APR. Annual Percentage Rate. It’s something that’s seen all over the place, and every place that advertises seems to tout how low it is. But what exactly is APR, and why is it important? Is it even worth it to fight someone over 1%?
“An annual percentage rate (APR) is a broader measure of the cost to you of borrowing money. The APR reflects not only the interest rate but also the points, mortgage broker fees, and other charges that you have to pay to get the loan. For that reason, your APR is usually higher than your interest rate.”
If you’ve seen APR mentioned, but never really thought about what it means or why it’s important, we’re here to be your guide. We want you to go into purchasing something on credit knowing what you’re getting into, and whether or not it’s worth it to fight someone over 5% instead of 4%.
To start off with, what is APR? APR stands for Annual Percentage Rate, which is the amount as a percentage you can expect to pay in interest annually, averaged over the life of the loan. This means that APR is compounded, which means that as you pay down the principal the amount paid to interest will lower. To break it down even further, if you borrow $100 and expect to pay it back over the course of a year, at an interest rate of 5%, you’ll be looking at $2.73 annually in interest, or approximately $0.23 per month in interest.
Seems easy, right? For most of your purchase, the APR will be simple to figure out. The biggest difference will be any credit card purchases, which not only use a variable APR, but since they’re considered revolving credit, the amount you’ll pay in interest each month will vary. For life’s major purchases, such as a car or house, however, the APR will still be able to be figured out around the same way.
So now that you know, at least as a rough idea, how APR is calculated, is it worth it to fight over that one percent? I guess it’s time to bust out the handy calculator again to determine this.
If you’re looking at purchasing a car, it may be worth it. Let’s say your car cost $20,000, and you’ve got 5% for a down payment. That means that you’ll be financing $19,000. If you finance that at 3% for 60 months, you’ll be looking at lifetime interest of $1,484, or $24.75 per month in interest. Let’s say you get the same car at 4% interest for 60 months. Everything else will remain the same, which means that your lifetime interest will be $1995, or $33.25 per month just for interest. If you’d like to save five hundred dollars, then yes, it’s worth it to fight for that one percentage point.
Houses can be a bit of an oddball as well, as you typically have the ability to take a variable APR. The math remains the same, however! If you buy a $150,000 house, but you have to finance $100,000, at a rate of 3% for 30 years, or 360 months, you’ll be looking at lifetime interest of $51,777. If you don’t fight for that interest point, and you get your house at 4%, you’ll be paying $71,870 over thirty years. Definitely worth putting up a fight for!
As you can see, APR is a pretty complicated system to get your head around, but once you understand what it is and how it can affect you, it’ll help you get the best rate for your purchases.