Why The APR is the Most Important Factor In Borrowing

Many people choose credit cards and loans based on the features, benefits, or the monthly payment, but there's a more important factor to consider - the APR. This number tells you how much you're actually paying to borrow money. The higher the APR, or annual percentage rate, the more you're paying when you borrow money.

Finding the APR

Looking at the APR gives you a better way to compare loan of the same type to each other. For instance, you would compare different mortgage loan offers based on the APR, but it's generally not helpful to compare a mortgage APR to a credit card APR since these are two different type of credit products.

Federal law requires all lenders to disclose the APR for loan products. If you don't see an APR posted prominently, dig a little deeper. It may be buried in the fine print. There's no harm in asking a customer service representative to give the exact APR if you can't find it on the website or in any documentation.

The APR also includes any additional fees included with the loan so you can get an idea of the true cost you're paying to borrow money. Loan origination fees or transaction fees that are automatically included with the loan are included in the APR. Transaction based fees like a balance transfer fee or late fee affect the overall cost of borrowing, but can't be predicted and aren't included in the APR.

APRs can be fixed or variable. A fixed APR stays the same over the life of the loan, which gives you more predictable interest and monthly payment. Since your monthly payment stays the same, a fixed APR makes it much easier to budget for your loan payment for the foreseeable future.

A variable APR will change periodically, usually based on an underlying market rate like the Prime Rate. Sometimes a change in the variable rate works in your favor, giving you a break on interest and a lower monthly payment. And sometimes, the variable rate swings the other direction, increasing with the market, leaving you with a higher monthly payment.

APR and short-term loans

Short-term lending costs are often expressed as a fee, but actually have a high APR. For example, a $100 two-week payday loan with a $15 fee has an APR of almost 400% and a $24 overdraft with a $34 fee that you repay in 3 days has an APR of 17,000%. The fees don't seem high individually, but are actually more expensive than many loans and credit cards if you repeatedly use short-term borrowing.

How your credit comes into play

Depending on the loan product, your APR may be dependent on your credit history. Generally speaking, the better your credit score, the lower the APR you qualify for. For major loans, like a mortgage or auto loan, it may be beneficial to work on improving your credit score. Shopping around and comparing loans based on APR and other factors gives you the best chance at landing an offer that works for you. Even with a great APR, it's still important to make sure you end up with a monthly payment you can afford.