What Is APR and Why Should You Care?

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Annual percentage rate, or APR, is the annual cost of borrowing money, including interest charges and fees. APR can be fixed, as is the case with most mortgages and auto loans, or you can have a variable APR, which most credit cards use. Here's an overview of what APR means and why it's important for you to understand.

What does APR mean?

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APR stands for "annual percentage rate" and is the annualized cost of borrowing money, expressed as a percentage.

You may be thinking, "Isn't APR the same thing as an interest rate?" While there are many similarities between the two concepts and the terms are often used interchangeably, there are some important differences to be aware of.

An interest rate is the price you pay for borrowing money, expressed as a percentage of the amount you're borrowing. For example, if you have a mortgage with a 4% interest rate, the bank charges you interest -- also referred to as a finance charge -- at an annual rate of 4%, applied to your outstanding balance. However, this doesn't necessarily reflect the entire cost of borrowing money.

APR, on the other hand, is a more complete expression of the actual cost of borrowing money. It includes the interest you'll pay, as well as certain additional fees you pay to borrow.

For this reason, the APR and interest rate you'll pay on certain types of borrowing are usually different. Mortgages are an excellent example, as expenses such as your origination fee are included in the APR. As a personal example, my mortgage has a 4% interest rate, but my APR is closer to 4.2%, reflecting the additional costs of borrowing the money.

It's also important to point out that in order to be factored into APR, a fee or expense must be directly related to borrowing the money. In other words, when you buy a home, you generally have to pay a few months of property taxes and insurance in advance. These costs are not included in the APR calculation, because they aren't directly related to borrowing money.

How credit card APR works

With credit cards, interest rate and APR can be used interchangeably, since there are typically no fees other than interest that are charged for borrowing money on a credit card. Many credit cards charge annual fees, but since these are charged regardless of whether you use the card or not, they're not directly related to borrowing, and are therefore not factored into your APR. Therefore, if your credit card has a 16.99% APR, this is also the interest rate that your card issuer charges for borrowing money.

Credit card interest is typically compounded daily, and your daily interest rate is calculated by dividing your card's APR by 365 days, although some card issuers use 360 days. So, a 16.99% APR would translate to a daily interest rate of roughly 0.0465%.

In order to calculate the interest charge on your monthly billing statement, your card issuer will multiply the number of days in the billing cycle by your average daily balance for those days.

Finally, it's important to mention that most credit cards have variable APRs that can change over time. These are based on certain interest rate indexes, such as the U.S. Prime Rate. If the underlying index rises, your credit card's APR will rise, as well. In fact, WalletHub estimates that the 25 basis-point (0.25%) rate hike by the Federal Reserve in March 2017 would cost American consumers an additional $1.6 billion in finance charges throughout 2017, and that's in addition to the other rate hike that's happened since then.

Low-APR credit cards

The average credit card APR is about 15%, and many consumers pay rates that are significantly higher. For consumers with less-than-excellent credit, APRs approaching 30% aren't unusual.

Fortunately, there are low-APR credit card offers that can allow you to finance purchases and pay significantly below-average interest rates. These come in two general forms -- credit cards with temporary 0% intro APR offers, and cards with permanently low APRs.

As of this writing, there are credit cards with 0% intro APR offers for as long as 21 billing cycles, and cards with permanent variable APRs as low as 13.99%. Be sure to check out our up-to-date list of the best low-APR credit cards if you're one of the millions of Americans who regularly carry a credit card balance and want to spend as little of your hard-earned money on interest as possible. If you have an existing credit card balance and are tired of paying so much interest, there are also some excellent offers for 0% intro APRs on balance transfers.

Competition among credit card issuers has never been stronger, so the offers that exist now are among the best I've ever seen. If you're paying 15%, 18%, or more for the privilege of owing a credit card issuer money, it could be in your best interest to take advantage of lower rates.

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