What is the definition of annual percentage rate, or APR?
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An annual percentage rate (APR) is the annual finance charge for a loan or line of credit. APRs will always include the interest rate for the loan or line of credit and sometimes will include any associated fees. An APR is always expressed in a percentage. For example, if the APR on a personal loan is 10%, you will pay $100 per year for a loan of $1000.
APR and the Truth in Lending Act
The federal Truth in Lending Act (TILA) requires that banks disclose the APR associated with the loan or line of credit to the consumer before the consumer agrees to the contract. This is to ensure the consumer has an understanding of what their monthly payments actually cover. In turn, the consumer can shop around for the best deal and ideally avoid signing a contract for a loan that would put them in financial trouble. For example, when applying for a mortgage, the APR must be disclosed to the consumer within three days of the application. While credit card companies are allowed to advertise monthly interest rates, before the consumer signs for the credit card, the credit card company must inform them of the annual percentage rate. The rate would be twelve times the monthly percentage rate.
Understanding What Is and Isn’t Included in APR Quotes
While the Truth in Lending Act requires that the bank inform you of the APR on the loan or line of credit, the Act did not standardize the APR. This means that APRs can still be confusing to consumers, because depending on the type of loan or bank, additional fees outside the interest rate may or may not be included in the APR quote. For example, while a mortgage company often includes private mortgage insurance and processing fees within the APR, other fees may be left out. Further, many times credit card APRs do not include fees in the percentage, such as transaction and late fees, as these are calculated separately from the APR.
Credit cards may also have several different APRs per card. These include an APR for credit card purchases, cash advances, and a default APR. The default APR is the APR that the credit card reverts to if you are late on a payment or go over your credit limit. The cash advance APR will generally be higher than the APR for credit card transactions and the default APR will generally be the highest. All of these APRs must be disclosed to you before you sign the contract.
Getting Clarification on APRs
Because of the lack of standardized APRs, you should be sure to inquire about any other fees that are not included in the APR when you are comparing credit cards or loans. You should also make sure you understand all of the APRs that one credit card can include. Always speak with a representative or agent about APRs before signing on the dotted line.