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Understanding APRs when shopping for a loan

March 24, 2015

By NerdWallet

When you’re shopping for a loan, it's important to understand how much it will cost you to borrow the money and pay it back. You won’t just be repaying the amount you receive from the lender; that money is called the principal. You’ll also have to pay interest, and there are usually other fees involved. As you look at different types of financing and different lenders, you'll probably see the phrase annual percentage rate, or APR. The APR is the total cost per year of borrowing money, and it's stated as a percentage.

APR vs. interest rate
When you borrow from a lender such as Alliant Credit Union, the interest you'll be charged is based on a percentage of the loan. Think of interest as the price you pay for using the lender’s money. The APR represents the interest a borrower pays plus any fees1 associated with the loan, showing the total cost to borrow the money. When you're ready to obtain financing, be sure to look at the language of the loan rates carefully; the interest rate and the APR may be different, depending on the fees involved, if any. If you look only at the interest rate, you may underestimate the total cost of your loan.

Cost of obtaining debt
When you borrow money from a financial institution, the APR takes into account several elements, depending on the type of loan. If it's a mortgage or a home equity loan, for example, you may have to pay closing costs and related fees, such as a title search or legal and appraisal costs. An auto loan APR might include an origination fee and a credit check fee. Before you commit to a loan, be sure to ask the lender exactly what fees you will have to pay and how much it’ll add to the cost of your loan.

Paying points
When it comes to mortgage loans, a home buyer sometimes pays points at closing. There are two types of points: origination and discount. Origination points are fees added to the cost of your loan. Discount points are a pre-payment of some of your interest upfront in order to reduce the interest and monthly payments over the rest of the term of the loan. One point equals 1% of the principal amount you're borrowing. If you choose to pay points, they are calculated in the APR.

Comparing rates
APRs provide a comparison tool to gauge the cost of borrowing. If you look at the APRs offered by various lenders for the same type of loan with the same terms, you can see who really charges more. A higher APR means you'll pay more for the debt by the time it’s paid off. Make sure you're comparing apples to apples when looking at APRs. A higher APR could reflect a shorter repayment period or a higher finance charge, for example.

Obtaining a loan can help you achieve your goals, from buying a car or a house to going to college. Before you commit to financing, though, make sure you know and understand how much it will cost you. It’ll help you manage your debt better in the long run.