If you have ever taken out a loan for a mortgage, automobile, education, or some personal reason, then you should know what an annual percentage rate (APR) is. At any rate, most people understand that it is some sort of charge on top of the loan. Despite that general concept, a ton of people don’t really understand how it works, and less than enough people seriously take APR into consideration before signing up for a loan. With that said, I am going to cover one of the most basic considerations that need to be made when you are shopping for different APRs on any sort of loan you may or may not take out. I’ll cover some basics by jumping right into it!
What is APR?
As mentioned earlier, APR stands for annual percentage rate. If it sounds completely foreign to you, then just think of it as an interest rate for now even though it is technically different. APR is how the banks and lenders make money! They offer a loan to a consumer and they tack on this APR. Each month, that APR defines how much you will owe in interest on top of the principal balance. For those who do not know, a low APR is preferable to a high APR. Higher APRs mean you’ll end up paying more in interest over the life of your loan.
How Does It Work?
Well, here is a quick run around on how APR works. The annual part means it is calculated over the year despite being applied every month. This is where many people (at least some of the people I’ve talked to) get confused. If you have a 12 percent APR, you will be charged 1 percent interest each month; at the end of the year, that amounts to your 12 percent APR. You will NOT be charged 12 percent each month! It isn’t technically an interest rate because it is taken as a percentage over the year; it’s APR! Despite that distinction, these two terms are used interchangeably all the time. Just know that APR is divided up by twelve months out of the year, and each month you are charged that much in interest each month on your remaining principal balance on the loan.
Typical APRs to Expect
So APRs are defined by whoever is issuing the loan, credit card, or anything else involving interest. These companies rely on an underwriting system that is heavily dependent on credit score, or in other terms, they take into account your credit history when deciding how much money they want to try and charge you each month.
If you are considered a high-risk consumer, that means you do not have a good credit history (just a reminder, having a bad credit history means you’ve struggled to pay your debts on time in the past among other things of course). If you are a high-risk type of person who misses payments from time to time, then you are going to receive a higher APR. Think of it this way. You have a high APR, and you’re terrible at paying your bills on time. The lender is going to make a fortune off of you eventually. Despite that cynical thought, the high APR may actually be meant to discourage you from borrowing a loan in the first place! These last couple of ideas are just some of my ideas, but it remains true that those with unworthy credit generally receive higher APRs.