Taking on a Loan: What Annual Percentage Rate (APR) Means

Not including retirement funds, most Americans have anywhere between $3,200 to $6,400 in their savings. While this can be enough to get you through an emergency, you might need more than what’s in your account for bigger purchases.

To skip the step of painstakingly saving, you can take out a personal loan. When you do this, you’ll see something called an annual percentage rate.

What is it, how can you get the best one possible, and what else should you know? Read on to find out more so you can make informed decisions.

What Is an Annual Percentage Rate?

An annual percentage rate (APR) is how much you pay to borrow money for a personal loan over its entire term. It’s typically written as a percentage.

There are two types of APRs: fixed and variable.

Fixed APR

With a fixed APR, you’ll know exactly what the interest rate will be for the entire duration of your loan, so long as your personal circumstances don’t change. For example, some lenders may raise their interest rates if your credit score decreases.

This means the APR isn’t dependent on the prime interest rate, which is the lowest rate possible reserved for the most credit-worthy customers. This is something that lenders use to determine what their APR should be. The prime interest rate is set by the Federal Reserve and is an industry benchmark.

If you like stability and predictability, then a fixed APR is ideal for you.

Variable APR

As the name suggests, a variable APR will change over time, and is usually dependent on the prime interest rate. Most credit cards use variable APRs, so if you’ve signed up for one before, then this is probably the type of APR you had.

A variable APR gives you less certainty, but it can sometimes save you money. But on the other hand, the APR can soar at times, and as a result, you’ll pay more in the long run.

If you don’t mind taking risks and want to possibly save money, then a variable APR can be better for you.

APR vs. Interest

Many people believe that the terms “APR” and “interest” are synonymous. However, this is a common misconception.

The interest rate is the percentage you pay back a lender, on top of the total amount you’ve borrowed. The APR includes everything; not only does this include the interest, but also all the fees.

How the APR Is Calculated

There’s a formula used to calculate the APR.

First, add the fees and total interest paid over the lifetime of the loan. Divide the result by the number of days in the loan term, and you’ll get your periodic interest rate.

Take the periodic interest rate and multiply it by 365. Multiply the result by 100, and you’ll get your APR.

What Factors Affect the APR?

A lender can offer the same type of personal loan and even the same amount to every customer. But not everyone will get the same APR.

Here are the factors that may make your APR different from another client’s.

Your Credit Score

The higher your credit score, the lower your APRs will be. This is because you’ve proven that you’re a responsible person by paying your bills on time, which is reflected in your solid credit score.

The lender takes on less risk if they give you money, so you’re rewarded with lower APRs.

Loan Amount

Each loan comes with administrative costs when processing. Lenders will charge fees to make up for these costs.

In general, you can expect higher loan amounts to have lower APRs. Smaller loans will have higher APRs because the administrative costs aren’t as worth it for the lenders.

Loan Term

The longer your loan term, the higher your APR will be.

If you can pay back the full amount in a shorter period, then the lender takes on less risk. And again, they’ll reward you for that.

Type of Loan

There are two main types of personal loans: secured and unsecured.

You’ll find lower APRs with secured loans because you need to give the lender collateral. This lowers their risk, as they can take something valuable if you aren’t able to pay your loan back in full.

If you’re not comfortable offering up collateral and potentially losing it, then turn to unsecured loans. These do have higher APRs, but at least you won’t lose something important.

Your Debt-to-Income (DTI) Ratio

Lenders look past your income and will weigh it up against your debt. After all, you can earn a fantastic salary, but if you’re hugely in debt, you still won’t be able to pay your loan back easily.

Customers with higher incomes and lower DTI ratios will be lower risks for lenders. Therefore, you’ll get lower APR offers.

How to Get the Best APR Possible

Two of the best ways to get the best APR possible are to improve your credit score and improve your DTI ratio. You can also opt for shorter loan terms, get a secured loan, and get a cosigner if you can’t wait to raise your credit score.

Don’t forget to shop around too. You’ll be able to compare APRs and pick the best one when you have more choices.

Sign up for a Personal Loan

Now you know what an annual percentage rate is and how it’s different from the interest rate of a loan. Not only that, but you’ve also learned how APRs can change and what you can do to get the best rates possible.

This should hopefully help you when browsing through your options for personal loans. You’ll feel more comfortable and confident picking something that works for you.

If you’re ready to get a personal loan, then get started now with FastLoanDirect. We’ll find personalized offers tailored to your needs.