When shopping around for a personal loan or a credit card, you will likely see lenders and banks advertise the annual percentage rate (APR) of their products. An APR is the total cost of borrowing that you will pay each year. The percentage includes the interest rate as well as any associated fees.
APR is useful because comparing this rate between different lenders provides a more complete picture of the value of different products. You don’t need to worry about adding any additional fees into your calculations.
APR for Personal Loans
The APR for personal loans is typically calculated using the loan’s interest rate in addition to application fees, insurance fees, document preparation fees, or any other type of fee—including the origination fee.
What Are Origination Fees and How Do They Affect APR?
Origination fees are charged by a lender to cover the costs of processing a loan. An origination fee might also be called an administrative, processing, or underwriting fee. Origination fees are generally between 1-8% of the total value of the loan.
How Are Origination Fees Determined?
A lender determines the amount of your origination fee according to several factors. They might take into account:
- Your credit score
- The size of the loan
- Your assets and liabilities (such as other loans you have taken out)
When Do You Pay Origination Fees?
Typically, origination fees are deducted from the proceeds of your loan. If you need to borrow money for a specific expense, you must take this reduction into account. You might need to borrow more than you originally intended.
For example, if you borrow $1,000, and the lender charges a 5% origination fee, you will only receive $950. However, you will still pay interest on the full $1,000.
If you need exactly $1,000, you must take out a loan for about $1,053. Then, once the lender applies the 5% origination fee, you will receive $1,000.
Choosing a Personal Loan Based on APR
APR Versus Interest Rate
Because an APR includes origination fees, it is better to select a personal loan based on its APR rather than the interest rate alone. The APR offers a true apples-to-apples comparison between different lenders.
Depending on the origination fee, a loan that has a higher interest rate might actually end up being cheaper overall.
Let’s say you want to take out a $5,000 loan with a maturity date in three years and make monthly payments. You are comparing loans from two lenders.
- Loan A has an interest rate of 10% and an origination fee of $100.
- Loan B has an interest rate of 8% and an origination fee of $300.
If you were only considering the interest rate of each loan, you would choose Loan A. However, the APR of Loan A (which includes both the interest rate and the origination fee) is 11.4%. The APR of Loan B is 12%.
While Loan A has a higher interest rate, it’s actually the more cost-effective option.
Representative APR Versus Personal APR
When browsing personal loans, you can often compare the APR of products from several different lenders. Something to keep in mind is that lenders often only publicize their representative APR.
When a lender posts a representative APR, it means at least 51% of borrowers receive loans at an APR at least as low as the posted rate. Individuals within that 51% percent may have a personal APR that is lower. More importantly, as many as 49% of customers could have a personal APR which is higher than the representative APR.
Do your research before applying for a personal loan. Your personal APR—affected by factors such as your credit history and the loan amount—could be higher than the representative APR.
After deciding on a lender, applying for a personal loan traditionally results in a hard inquiry into your credit. Hard inquiries can affect your credit score. So, be sure to get as much information about what your personal APR might be before applying. Consider first seeing if you pre-qualify for a personal loan, which will not affect your credit score.
APR for Credit Cards
Calculating the APR for credit cards is a simple task because credit cards do not typically charge origination fees. The APR is the same as the interest rate.
However, there are some things to keep in mind when deciding which credit card’s APR is the right fit for you.
Factors Affecting Credit Card APR
Unlike other types of credit like personal loans or mortgages, credit card interest is charged daily. So, if your APR is 20%, you’re getting charged about .05% every day. Therefore, it’s always a good idea to pay your credit card balances as soon as possible. Making a payment earlier in the month can help save you money. In fact, if you always pay the full balance on time, you won’t be charged any interest at all.
You may be tempted to get a credit card with rewards points, but in many cases, credit card offers with rewards can have a higher APR. Credit cards may also offer different APRs to different customers, taking into account a customer’s credit score. Credit card APRs also fluctuate based on changes to the prime rate.
Credit cards might have different APRs for different actions. For example, the cash advance APR is usually higher than the purchase APR for normal transactions. Some credit cards might have an introductory APR which then increases later on. Make sure to look at the terms and conditions of your credit card offer to fully understand the arrangement.
Fixed or Variable APR?
Whether you’re getting a personal loan or signing up for a new credit card, you’ll want to consider whether your product has a variable APR or a fixed APR.
A variable APR fluctuates and is typically tied to an interest rate index. If the index drops, so does your APR, so you end up paying less interest. However, the opposite is also true. If the index increases, so will your APR.
A fixed APR is not tied to an index, so you won’t be as exposed to interest rate risk. However, in some cases, the lender can still raise the APR, provided they notify you in advance. The higher APR will usually only apply to purchases made after the notification.
Wrapping It Up
When comparing personal loans and credit card options, looking at the APR can help you choose the right product for you. Your personal APR will vary based on factors like your credit score, your assets and liabilities, and the amount of the loan.