If you take out a loan for a new home or car or decide to open a new credit card, you likely have run into APR, which stands for annual percentage rate.
It can get confusing because lender sometimes advertise one interest in big, bold letters, then tack on “APR” in smaller letters.
Often, the APR figure is higher, which adds to the confusion.
Marketing tactics can make APR seem less important, or not legitimate. In fact, APR is the number you should look at, especially if you are considering multiple offers of credit.
APR exists because of a federal law, the Truth in Lending Act. The point of calculating APR is to include all of the upfront fees added in by the lender.
Those fees on a mortgage might include an origination fee, mortgage insurance and other closing costs. If the fees are financed as part of the loan, your monthly payment will be higher, naturally.
You could pay the fees in cash, but people often gloss over that and just finance the fees. The APR thus gives you a clear sense of the true cost of each loan you are considering.
Credit card agreements can be even trickier. There might be very different ways of calculating your percentage rate cost from card to card, plus late fees, annual fees and transaction fees.
Using APR instead allows you to make an apples-to-apples comparison before making a decision.
Naturally, it doesn’t end there with credit cards. There are different APRs applied to different types of transactions. You might pay one APR for a new purchase and another for a cash advance.
Many cards, too, offer what’s called an “introductory” APR, usually very low, to convince you to open the account.
It’s important to understand your actual cost of credit once that introductory period expires.
The goal of the credit card company, of course, is to get you used to using their card so that you don’t notice the higher cost six or 12 months later.
The Truth in Lending Act was put into place in 1968 to protect borrowers from confusing lender terms.
Besides APR, it requires that lenders provide clear, plain-English explanations of the cost of a loan and all fees.
In addition, the Act requires what’s known as a recission period. That means you have three days after signing a new loan to decide it’s not in your interest.
The lender then must cancel the agreement at no loss to the borrower.
MarketRiders, Inc. is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.