How does APR work?

With credit cards, your APR very simply is your interest rate: the percentage of your debt that you pay on an annual basis whenever you carry a balance from month to month.

But with other types of loans, APR is your yearly interest and more. The rate rolls in other expenses to give you a more complete picture of what that credit costs you.

For example, here's how APR works with mortgages, according to the U.S. Consumer Financial Protection Bureau: "In general, the APR reflects not only the interest rate but also any points, mortgage broker fees, and other charges that you pay to get the loan."

Because that other stuff is baked in, a mortgage APR is typically higher than a mortgage interest rate. A 30-year home loan might have an interest rate of 3.875% but an APR of 4.274%.

Whenever you comparison-shop for a mortgage, both the interest rate and the APR must appear as part of the loan estimates supplied by lenders. Later, you'll find both figures within your five-page mortgage closing disclosure form.

Personal loans are another type of loan with APRs that can include both interest and fees.

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Types of APR: fixed and variable

An APR can be either fixed or variable.

A fixed APR is boring and predictable: The rate won't change but will hold steady during the life of your loan. But don't yawn, because the APR's reliability is good for budgeting.

A variable APR lives a little more dangerously. The rate is tied to a benchmark rate, like the prime rate, and the APR can slide up or down depending on how the other rate behaves.

While variable APRs tend to be lower than the fixed variety, a variable APR comes with the risk that your rate could rise — making your loan more expensive — later on.

APR vs. APY

APR is often confused with APY, which is a way of expressing the interest on savings and investments.

APY is short for "annual percentage yield." Similar to the way APR often reflects the interest and other borrowing costs, APY is the interest rate plus compounding.

That's the interest that's paid on your interest as it builds up. As with APR, your APY will be higher than the basic interest rate.

Here's a very basic way of telling APR and APY apart: A low APR is terrific. A low APY — well, not so much.

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About the Author

Doug Whiteman

Doug Whiteman

Former Editor-in-Chief

Doug Whiteman was formerly the editor-in-chief of MoneyWise. He has been quoted by The Wall Street Journal, USA Today and CNBC.com and has been interviewed on Fox Business, CBS Radio and the syndicated TV show "First Business."

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