Q&A Video – What Is An APR?

John Ulzheimer

John Ulzheimer | Q&A Videos

Nov 13, 2015

The APR – Annual Percentage Rate – is a basic feature of revolving credit cards.  It is the fee that you pay to use the card, which covers the costs that the issuers pay to service the debt you accrue.  The APR is the interest you’ll pay from month to month; for general credit cards, the average is around 15% to 16%, while retail store cards usually have APR’s above 20%. Learn all about APR’s in our video with credit expert John Ulzheimer.

Transcript

Hi, my name is John Ulzheimer, and I’m a credit expert who contributes to CreditCardInsider.com.

Today’s question is: What is an APR?

So an APR, well APR is an acronym that stands for annual percentage rate. And an annual percentage rate is a single percentage that represents the actual yearly cost of servicing some form of debt, like a credit card, or an auto loan, a mortgage, student loan, any type of liability where it’s accruing interest is going to have an APR. And the APR is also supposed to encompass the cost of fees as well the cost of any interest.

The average interest rates, or the average APR, is going to vary by loan type, or by liability type. So for example, in the credit card world, the average APR is somewhere between 15 and 16 percent for a general use credit card like a Visa, a MasterCard, American Express or Discover.

For retail store cards, which are cards that are issued with the branding of one of the stores where you like to shop, they’re going to have much higher APRs. The APRs for those types cards can run well into the 20 percentage point range and it’s generally one-size-fits-all, which means that regardless of how good your credit happens to be, you’re likely going to get that type of interest rate.

Credit cards have what’s referred to as variable interest rates, or variable APRs, rather than what’s referred to as a fixed APR. A fixed APR means that your interest rate stays the same over time. Credit cards now have variable APRs, which means that they’re tied to the prime rate, which is referred to as an index. And every time the prime rate changes, there’s a possibility that the interest rate on your credit card is going to change.

Now, the prime rate hasn’t changed in many years. It’s still 3.25 percent, but many experts believe that in 2015 it’s actually going to go up. So it’s very possible that the APR on your credit cards is also going to go up because it’s likely tied to the prime rate.

Now, interest rates and APRs for credit card accounts are only meaningful if you’re actually carrying debt on the card meaning that you revolve, or roll, or carry a balance from one month to the next without paying in full. At that point you’re going to accrue interest and that’s based on the APR. If you pay the balance off in full every single month by the due date, then really the APR becomes meaningless because you’re not paying interest anyway.

APRs on mortgages today are somewhere between 3.75 and 4.5 percent for people who’ve got very good credit, but they can go as high as greater than 6 percent for people who have poor credit. And the APR for a mortgage loan is generally calculated based on your credit reports, your credit scores, and other wealth metrics like your income, the amount of savings you have in reserves built up, and also collateral value of the house.

So things that you’re not even thinking about when it comes to credit cards are considered in mortgage lending because it’s a different type of loan. Usually a much higher dollar loan.

For auto loans, interest rates or APRs could be actually as low as 0%. There are some financing sources, generally referred to as a captive, and a captive is the financing arm of the manufacturer, like Ford Motor Credit or Toyota Motor Credit, or Honda Finance.

Those guys generally finance cars built by their manufacturer. Because they’re the captive auto lender, they’re able to offer much more aggressive interest rates, and in some cases if you got get enough credit, that interest rate could be as low as 0 percent. Because they want to move the unit off the lot, get it on the street, so they’re actually willing to let you have essentially free money in order to sell the car. They’re making margin in the sale the car course, so they have another way to fall back on revenue, where most lenders who are lending money for car loans are falling back on nothing other than just the APR or the interest rate.

APR are set in almost all cases based on credit risk, or the risk of the lender doing business with you. So things like your credit scores, and the information on your credit report, and in the mortgage environment, wealth metrics and collateral value, those things are all kind of glommed together and determine the overall risk of the lender doing business with you. And that’s how they’re going to determine the APR. The APR is the way that they can subsidize the risk of doing business with you by making more money from the entire group of people who have similar risk profiles.

If you’ve got really really solid credit, you’re going to get a very aggressive APR. If you’ve got mediocre to poor credit, you’re going to get a not so aggressive APR. If you’ve got bad enough credit, then there isn’t a high enough percentage rate that they can charge you to subsidize the risk of doing business with you. You’re just simply too much a hot potato.

If you have any other questions pertaining to credit, or other financial topics, please submit them to CreditCardInsider.com.

Thanks for watching have a fantastic day.

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