What is APR? A Simple Explanation
In the world of finance it’s easy to get lost in a sea of acronyms–APR, EBT, ARM–but there’s no reason to be intimidated. If you’ve got questions, we’ve got the answers. Read on to learn more about what APR is and how it can impact your small business lending decisions.
What is APR?
First, let’s start with what the letters A, P, and R stand for: Annual Percentage Rate. When you go loan shopping, you will definitely want to keep track of the APR you’re quoted. That’s because this number holds the answer to one of life’s great questions–What’s it gonna cost me?
Well, it’ll at least give you some answers where loans are concerned.
The annual percentage rate on a loan or line of credit is the price you pay for borrowing money. It includes the annual interest rate plus any automatically included fees. Let’s say you’re quoted an annual interest rate of 15% at two different lenders, but in addition to the interest rate, one lender’s fees amount to an additional 3% and the other lender’s fees amount to 4.5%. If all a lender had to disclose to you was the interest rate, you’d think both loan products were identical. That’s why APR is important. It shows you the difference in the cost of borrowing money from lender to lender. For instance, at the first lender, the combined cost to you would be 18%, and at the second lender the combined cost would be 19.5%. The more money you borrow, the more that 1.5% difference will cost you.
By combining fees and interest, APR helps you make a true comparison. And every lender has to disclose their APR before you sign on the dotted line. So, given two five-year loans of equal size, which one are you going to pick? The one with the lowest APR, of course.
Is There a Catch?
Just remember that lenders are competing for your business and they want to make their products as attractive as possible. That means it’s your job to make sure you’re comparing apples to apples.
For example, sometimes personal and business credit card companies will raise their interest rates, notifying you of what seems like a small monthly increase. The problem is that your monthly interest rate is not equal to your APR–not even close. Plus with compounding interest, calculating your total costs can be a little tricky. Don’t confuse the two terms. If a lender isn’t giving you the APR, try using an APR calculator to figure it yourself.
There are a couple more things to keep in mind when it comes to APR:
- With variable interest rate products, you might be quoted an average APR. Although the average might seem helpful in theory, it’s a lot less useful in practice. A loan could have a 3% introductory APR that jumps to 5% after two years. What that will cost you in the end depends on how quickly you are able to repay the loan.
- Credit cards can trip you up as well if you’re not paying close attention. The representative APR, the APR the card company uses for advertising purposes, is the APR received by the majority of cardholders. However, if you’re not a “representative” cardholder, your APR will probably be higher.
While the answer to the question “What is APR” is pretty cut and dry, how it gets used by various lenders to make a product seem more appealing might not be so straightforward. Remember to read the fine print.
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