What Does "APR Interest Rate" Mean?
Annual percentage rate (APR) is a term frequently used in the banking industry in conjunction with loans like mortgages. The APR interest rate of a certain loan is the annual cost of the loan taking the interest rate (6.5 percent of the loan amount, for example) into account as well as other financial charges and costs associated with the loan.
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Significance
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APR signifies the annual cost of a loan. Interest payments are only one of several possible costs that go into the total annual cost of a loan. For instance, mortgages often require mortgage insurance if the down payment made is too small. Comparing interest rates to find the best deal on a loan is, therefore, not a productive practice. Instead, the APR of various loans should be compared.
Benefits
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The use of APR allows lenders to advertise loans in a way that consumers can understand and easily compare to competitors. APR helps consumers judge the cost of a loan without needing to know all the specific details about the interest rate and other costs that go into the APR.
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Drawbacks
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The concept of APR can be confusing to some consumers, and lenders may not include all costs in the APR. According to the Lending Tree website, some upfront costs such as home appraisals, credit reporting fees and title fees may not be included in APR. APR is also less useful when figuring adjustable rate loans. With adjustable or variable rate loans, the interest rate can change over time, meaning posted APRs may also change over the life of the loan. Fixed APR loans are usually considered safer than variable rate loans since the entire cost of the loan is known upfront.
Misconceptions
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The term APR is sometimes used to denote the simple annual rate of interest paid on interest-bearing accounts such as savings accounts at banks. This usage of APR should not be confused with the usual meaning of APR that is used when referring to loans. If you are looking to open an interest-bearing account, the most important number is the annual percentage yield or "APY." This number indicates the effective annual rate of return the account will bear taking interest compounding into account.
Considerations
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Lenders may differ as to what extra costs they include in their posted APR and what costs are not included in APR. Costs that are not included APR could potentially make a loan with a higher APR cheaper than one with a lower APR if the lower APR loan has several costs that are not included the APR.
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