Understanding Interest Rates vs. APR
Though a common misconception, the terms interest rate and APR are not the same thing. The two are similar, but do not have the same definition. APR, or annual percentage rate, is a type of interest rate. There are numerous types of rates and this is just a single one. To fully understand the rates you are charged, it is important you know how an APR interest rate differs.
Interest Rate Vs APR – Which Is More Important
One is not necessarily any more important than the other. It all depends upon the terms of your lender. For instance, credit cards have an APR, while short term loans only have a periodic interest rate. This is why it is vital you carefully look at interest rate comparisons to see which types of rates you will be charged.
If APR is involved, the lender is legally required to provide you with this rate upfront – the same for any other type of interest rate. Every interest rate is important. What many consumers do not realize is multiple interest rates may apply to a single loan. This is most common in credit cards.
For instance, the average credit card may have a purchase APR of only 8%. This applies to purchases you make on a daily basis. If you pay off the owed amount each month, you pay no interest. Cards usually have higher APR for balance transfers, such as 15%. When looking at rate vs APR, take every interest type into consideration. More than one rate may apply.
APR Explained
As with interest rates, there are multiple types of APRs. The four main types include:
- Introductory
- Penalty
- Fixed-rate
- Variable-rate
When you first receive a credit card, you might qualify for an introductory APR. By law, this rate must last at least six months. Carefully read the terms to ensure you know exactly when the introductory period ends. Most rates start between 5% and 9%, though some cards actually offer lower rates, especially for balance transfers. Often, these rates are as low as 1%. After this period, though, your APR will increase, sometimes even doubling.
Though you already know the importance of paying your bill on time, you may not know you could face a penalty APR for paying late. Add a higher interest rate to your penalty fee and it pays not to miss a payment. The higher APR applies to all purchases made after you triggered one of the penalties listed in the contract terms.
Ideally, a fixed rate APR is best. For a set period of time, your rate cannot rise. The downside is it will not decrease either. These are perfect if you are able to fix a low rate in the beginning.
The opposite is the variable-rate APR. As interest rate indexes change, your rate can increase and decrease. This is outside the credit card company’s control. They will disclose how often your APR may change.
What Exactly Is An Interest Rate
In short, an interest rate is the price one pays for borrowing money. Think of an interest rate in terms of sales tax. If the tax is 5%, you will pay an additional five cents for every dollar you spend. If you borrow $1000 with a simple interest rate of 5% with a term of three years, you would actually pay back $1150.
Understanding Interest Rate Vs APR
Rates are not about interest rate vs APR. It is not an either/or situation. Instead, APR is a type of interest rate. APR is most often associated with credit cards, which may have multiple types of APR rates.
Learn how to get lowest fixed rate credit card deals and information about are rewards cards good for your bottom line, written by our team of financially savvy editors and writers, with links to credit card deals.
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