Understanding Your Credit Card Or Loan APR

The Annual Percentage Rate on your loan can be a confusing thing. But with this handy guide, you’ll get to know them like the back of your hand.

Determining exactly what your Annual Percentage Rate, better known as your APR, means can be a confusing challenge. But if you want to be a responsible consumer, you’ll need to know some basic facts about the APR on your credit cards or loans. Otherwise, you run the risk of paying too much for the money you are borrowing.

At its simplest, APR is a measure of how much a given loan or mortgage will cost you in interest payments throughout the calendar year. The figure for APR takes into account all of the normal fees associated with your loan. This can include annual charges, arrangement fees and other costs.

When you take out a mortgage, auto or other loan, you’ll receive a payment schedule. Your payments reflect your APR. As you make your payments over time, a smaller amount of each payment will go toward paying off loan fees and interest. More of your payments will eventually go toward reducing the principal balance of your loan.

Here’s an example of how APR is calculated: Say you take out a loan for $100. Your lender might charge you $10 in loan fees. You might also have to pay $39 worth of compounded interest during the life of your loan.

To determine the APR on this loan, you take the sum of the compound interest and the loan fees, which equals $49, and divide it by the total dollar amount of the loan. In this case, 49 divided by 100 equals an APR of 49 percent.

Figuring the APR on your credit card purchases can prove a tricky matter. That’s because credit card companies typically charge different APRs depending on the type of credit card purchase that you are making.

For instance, the purchase APR is the rate that you incur every time you make a purchase with your credit cards. The balance transfer APR is the rate that your credit card company charges you whenever you transfer over a balance from another credit card. The cash APR kicks in whenever you make a cash advance with your credit cards. Finally, the default APR is the rate that all of your other credit card APRs will adjust to if you don’t pay your credit card bill on time or if you go over your maximum available credit.

Compounding is another term that’s important for you to learn. Basically, it refers to earning interest on previous interest. You want to maximize compounding on your investments because it makes your dollars grow at a faster rate. You want to minimize compounding on your debts, though, because it makes the money you owe grow at a quicker rate.

Before taking out a credit card, make sure you understand how your debt balance is calculated. Different cards figure this in a different ways, and it can make a significant difference in the way your debt grows.

Those cards that use the daily balance method to determine your finance charge calculate the actual balance you carried each day of your billing cycle and multiply it by roughly 1/365^th of your APR and add the daily values together to determine your finance charge.