What Does APR Mean?

What does 0 APR meanUnless you’ve just woken up from a 100-year sleep, you’ve heard the phrase “APR” mentioned in countless car commercials, radio ads for home loans, credit card offers, and other forms of communication. But what does APR mean exactly?

Well, there’s the short answer and the long answer. The short answer is that APR stands for “Annual Percentage Rate.” But you probably already knew that. Let’s dig a little deeper to find out how it works.

Interest Rate vs. APR

Borrowing money can be expensive. Whoever you choose to borrow from will want some compensation in return. Usually, they’ll charge you an interest rate, which requires that you pay them a certain percentage of the principal (the amount you borrowed) at certain intervals. But the interest rate doesn’t specify exactly how much interest they can expect to receive from you on a yearly basis in return for lending you their money. And that’s what APR measures – the agreed upon yearly rate of return on the money that’s been borrowed.

However, it gets slightly more complicated. With most consumer financial products there are some other factors that play a role in what your APR will be. One of those factors is whether you have a fixed or variable interest rate:

  • A fixed rate means that the company lending you money has agreed to hold your interest rate steady at a level you agreed to when you initially borrowed the money (or signed the contract).
  • A variable rate means that the company reserves the right to raise your interest rate depending on certain external factors, such as the prime rate. Keep in mind that even if you have a fixed rate, your rate can still be increased if you break your part of the agreement (i.e. if you make a late payment).

The other thing that determines how your APR works is whether we’re talking about a credit card a mortgage, a car loan, or some other type of financial product. Below, we’ll explain how APR works for each type of credit…

What does APR mean for credit cards?

When you have a credit card, you only have to pay interest if you don’t pay your full statement balance for each billing cycle. That means you can have a credit card without paying any interest as long as you always pay your bill in full! However, if you go at least one billing cycle without paying the full balance, you’ll begin to be charged interest immediately (see below). And of course, even when you’re always paying your full amount, you might still be charged fees – so check your credit agreement.

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Once you’re in a position where you’re not paying in full and you’re carrying a balance from month to month, you’ll be charged interest on a daily basis – that’s right, a daily basis! Most credit cards calculate your monthly finance charges based on a method known as Average Daily Balance (ADB). To calculate your ADB, add up your balance at the end of each day of your billing cycle and divide that sum by the number of days in your billing cycle. Then, use your APR (written as a decimal) to determine what your finance charges will be, using this equation:

ADB x APR x Number of days in billing cycle / 365 = Your monthly finance charge

This calculation means that it’s always better to make payments as soon as possible toward your credit card balance. If you have a check for $1,000 that you want to use to pay off credit card debt, you should send it in immediately rather than wait until you receive your next billing statement. Otherwise, your average daily balance for that period would be higher than it needed to be – resulting in more finance charges for you.

(See our article How Does Credit Card Interest Work? for more information)

What does APR mean when buying a car?

An APR on an auto loan works similarly to an APR on a credit card, with the main difference being that your auto loan is an “installment” debt (the amount and repayment period are set in your contract) while your credit card balance is a “revolving” debt (the amount depends on how much you spend and how much you decide to pay off). Just remember that everything is negotiable when it comes to buying a car, including the APR.

When you are going over the financing options with the dealership, they may try to add 2-3% onto your APR beyond what’s necessary, and that extra amount will go directly to them (i.e. a nice little commission)1, so you should always do research beforehand and be prepared to show them competitive rates from your local bank or credit union to prevent them from jacking up your APR. And be ready to back up your promise to get the loan from the bank instead of the dealership if they don’t make a fair offer.

What does APR mean when buying a home? (Mortgage APR)

If you’re planning to buy a home or already have a mortgage, you need to understand what an APR means in this context. In essence, the APR for a mortgage includes all costs you pay (including origination fees, etc.) so that you have an idea of how much you’re paying on a yearly basis to own the house. This is different from the interest rate, which only tells you how much interest you must pay on the principal each month – but doesn’t include fees.

For example, if your mortgage loan is for $300,000 and you pay $8,000 in costs associated with getting the loan, then usually the $8,000 is taken from the loan – meaning your loan is actually providing you with $292,000 while your monthly payments reflect a loan amount of $300,000. Since your interest rate does not reflect those extra costs, it’s important to pay attention to your APR because it will tell you how much you’re paying in total – including the extra costs. That’s important to know when you’re comparing different mortgage rates.

What Does 0% APR Mean?

Many advertisements for credit cards and auto loans these days proudly announce that they have a 0% APR (for an introductory period).

So what does 0% introductory APR on a credit card mean? Well, it does mean you can avoid paying finance charges during the introductory period, but you won’t avoid finance charges unless you pay off your balance in full before the end of the introductory period. If you don’t, then you’ll be charged interest on the remaining balance. Also, if you are late on your payment during the introductory period, then the 0% APR is nullified and you’ll be stuck with their regular APR which is probably 15% or higher.

Also, keep in mind that only a select group of people are eligible for the 0% APR offers. You must have a good credit score, and for car buying you often must have a significant down payment – of at least 10%.

If you see a car commercial promoting one of these 0% offers and then you go to the dealership ready to sign on the dotted line, you may be surprised to find out that the 0% APR is not available to you. But once you’re there, the sales rep will surely be happy to sell you a car anyway, whether it’s in your best interest or not!

So approach 0% APR offers with a healthy dose of skepticism. If you’re eligible, and if you are confident you’ll be able to pay on time each month, then it’s probably a good deal for you. Otherwise, try to avoid getting caught up in the “hype” and signing up for something that will cost you a lot of money in the long run.

———

Knowing how APR works will give you the financial aptitude to make good decisions when getting a credit card, taking out a mortgage, or applying for a car loan. It will also help you avoid any 0% APR offers that might not be legitimate or trustworthy.

If you have any further questions about APR, feel free to let us know in the comments section below.

This article is part of our Credit Card Debt Resource Center.  If you’re looking for additional information about credit card debt, be sure to pay a visit!

  1. Source: Beware of Car Dealer Loan Rate Markups – Consumer Reports []

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  • Jenna from Adaptu

    Great breakdown of what APR is and it’s various forms.  Thanks for sharing!

    • http://www.twitter.com/bwfeldman Benjamin Feldman

      Thanks, Jenna! Much appreciated. I hope people will find this information useful.

  • kellylynn1

    This article was very informative. I didn’t know about the car dealers adding their own commision to the current rate. Good to know.

    • http://www.twitter.com/bwfeldman Benjamin Feldman

      Hi Kelly, thanks so much! I didn’t know about the commission either, until I did some research. Let us know if you have any further questions.

  • Drdrap

    There is some confusion. I don’t think you have to pay your balance in full if you have 0% APR for introductory period. It is usually stated “interest does not accrue prior to the End Date on an Interest-free Equal Payment Purchase.”

    • Drdrap

      I mean you don’t have to pay your balance in full EACH month. For example if you have 1200$ for 0% for 12 month as far as you paying 100$ each month (for example) you going to be fine. Am I right?

      • http://www.twitter.com/bwfeldman Benjamin Feldman

        You’re right. You don’t have to pay your balance in full each month to avoid interest, you just have to pay it in full before the introductory period ends. Thanks for catching this! I’ll edit the post to reflect this.

  • Drdrap

    Also, your monthly finance charge formula is not completely right you supposed to divide everything by 100, because APR is showed in %. And your statement about about car dealers taking some percent from your loan as “commisions” is weird. Can you prove this? Just your opinion? Guys, you really should read some papers before signing them. Also, you should be more kompetent in your articles ;)

    All the best.

    • http://www.twitter.com/bwfeldman Benjamin Feldman

      The equation for finding your monthly finance charge requires that you enter the APR as a decimal (or divide by 100, as you mentioned). So if your APR is 15%, you would write it as 0.15 or as 15/100. I’ll update the post to make this more clear.

      As for the commissions charged by car dealers, I’ll add a footnote citation with a link to a Consumer Reports article verifying what we wrote.

      A lot of our readers find our information very helpful (not to mention competent) and we hope you will too!

  • VJ

    If I get approved for this online credit card but I make one purchase using the card. If I pay that purchase off in full, if I don’t make another purchase for three months using the card do I have to worry about any fee between those months that I haven’t used my card or is it “pay for what you buy” thing with credit cards?

    • http://www.twitter.com/bwfeldman Benjamin Feldman

      Hi VJ, usually if you have paid off your balance in full then you should not be charged any interest. However, the fees depend on the agreement with your credit card company, and sometimes the fine print includes fees that you would not expect. The best thing to do is read the fine print very carefully and ask them about any suspicious fees that you see mentioned. If there are too many fees listed, look for a different card or consider using debit or cash.

  • Bob Wilson

    You misunderstood on the car loan, if you qualify you get 0%. If your credit isn’t up to it you get a higher rate. Not a trick all credit will work this way.If you have poor credit and can still buy a car sounds in your interest to me.

    • http://www.twitter.com/bwfeldman Benjamin Feldman

      This is similar to what is stated in the post. For those who have a good credit score, they may be able to qualify for a 0% interest car loan. But for those who do not, they will often be eligible only for the higher interest car loans (not 0%). Thanks for your comment.

  • Consumer

    Hi I have a 0% ape credit card with capital one If I make the minimum payments will that affect my credit score in any way?

    • http://www.twitter.com/bwfeldman Benjamin Feldman

      In general, making payments on time is one factor in building a good credit score. So yes, if you make your minimum payments it should help your credit score. For more information, see our Credit Score Resource Center:
      blog.readyforzero.com/resources/credit-score

  • Person

    I have a credit card with capitol one and chase freedom, both of them offer 0% apr for the first 15 billings cycles. I have been paying them off in full each month. If I do carry a balance over from one month to the next, will this negatively affect my credit score even if I am still making the minimum payments?

    • http://www.twitter.com/bwfeldman Benjamin Feldman

      No, that will not in itself hurt your credit score. But if you begin increasing your credit utilization ratio, that could eventually affect your score. For more information, see our credit score resource center:
      blog.readyforzero.com/resources/credit-score

  • amb53

    How do I lower my APR?

    • http://www.twitter.com/bwfeldman Benjamin Feldman

      One of the best ways is to call your lender and ask them for a lower rate: blog.readyforzero.com/lowering-interest-rate-simple-phone-call/. You can also look into things like balance transfers and debt consolidation loans.

  • Stan jones

    Thanks SOO much! I need this info exactly!

    • http://www.twitter.com/bwfeldman Benjamin Feldman

      Wonderful! I’m so glad this article was helpful. Thanks for your comment.

  • Daniel Lefebvre

    With a balance transfer that has a 0% apr on a credit card. I thought that meant that I would not be charged any interest until the agreed upon date. But on the agreement it seems to contradict itself. Am I misreading this?
    Promotional APR: Your promotional APR(s) will apply only to the transferred balance. At the end of this promotional period, your APR will be at your standard Purchase/Balance Transfer APR, which you can view below and also find online by viewing the account details page or a recent online statement.
    0% APR through your billing cycle that ends in 05/2015; thereafter

    19.24% variable APR based on the Prime RatePaying Interest: We will begin charging interest on this transaction on the transaction date; there is no period to avoid paying interest on this balance. Please see your Cardmember Agreement for details.

    • http://www.twitter.com/bwfeldman Benjamin Feldman

      It sounds like your 0% APR only applies to the transferred balance and does not apply to any new expenses you put on the card.

      I’ve heard of this before, so I know it’s not uncommon. At least you caught it now, in time to protect yourself!

  • Susie

    so, if it says 0,00% APR payment plan for the life of the account, as long as payments are made on time there is no interest???

    • http://www.twitter.com/bwfeldman Benjamin Feldman

      It sounds like it. But do read the fine print. Sometimes, the 0% rate only applies in certain situations and can be revoked if you miss a payment or some other unexpected event takes place.

  • Jallie

    =_=

    They never taught us this terminology when I went to high school. Now as an Adult Student, I realize how much I’ve missed when it came to financing.

    Thank God i’m not in 50k debt like other students for their degrees. I’m just struggling on a 3,400 debt right now on a minimum wage job.

    • http://www.twitter.com/bwfeldman Benjamin Feldman

      You’re right – this stuff is not taught in schools, and it probably should be. It sounds like you’re learning it now, which is great! And the $3,400 of debt on a minimum wage job sounds like quite a challenge – but I’m sure you can do it, and hopefully we can help. Have you tried using ReadyForZero yet? Let us know what you think and feel free to post any further questions you have!

  • nick

    I have a question about intro APR. I got new credit card which offers 0% intro APR. I planned to spend money about $2500 with this credit card. I might not pay off this money immediately and plan to pay this in 3 months. Is there any interest on my payment?
    And if I pay this in 3 months, will it hurt my credit score? what’s the expected disadvantages from paying money in 3 months?

    • http://www.twitter.com/bwfeldman Benjamin Feldman

      Hi Nick, most credit cards with a 0% APR introductory offer come with some kind of introductory period (usually 6-18 months) in which you are not charged interest. That would mean that as long as you make the monthly payments and get the debt paid off before the end of the introductory period you would be fine.

      However, I would strongly recommend checking the fine print on your credit card agreement because that is the only way to know for sure that you understand the terms correctly. Good luck!