Annual Percentage Rate (APR)
You may have seen the term APR, or annual percentage rate, used in reference to everything from business loans to credit cards. Understanding how lenders calculate APRs and how they work can help you make more informed small business loan decisions. Here is everything you need to know about annual percentage rates.
What is Annual Percentage Rate (APR)?
The annual percentage rate or APR is a term that every small business owner should know about. It refers to the rate at which a borrower is charged on a loan- such as a traditional bank loan or credit cards invoice financing- calculated over a period of twelve months. In other words, APR is a term used to express the numerical amount paid by a small business on a yearly basis for the privilege of borrowing money. It gives borrowers a snapshot of what a credit card or loan will cost them, and provides them with a holistic view between lenders, credit cards, or investment products- this includes any fees or additional costs associated with the transaction.
How Does APR Work?
These fees and costs will vary depending on the type of loan or product a business is applying for. A few examples of fees that are included in the APR are broker fees, closing costs, processing fees, underwriting fees, and document fees- all often expressed as a percentage.
Also, keep in mind that the annual percentage rate is different from the interest rate of a loan, for the simple reason that the APR includes costs and fees associated with the loan, and the interest rate does not. Paying attention to the interest rate alone is not an effective way to evaluate a loan. The annual percentage rate is much more effective, as it uses the interest rate and adds in any other costs to finance the loan, providing a much clearer image.
Fixed vs Variable APR
A fixed APR, as the name indicates, typically will not change over time. It will remain constant during the entire term of the loan. However, a fixed APR can change under certain circumstances- like a missed payment- but when this happens, the lender must notify the borrower before the changes occur and can apply the new rate to purchases and other transactions they make after they get the notice.
A variable APR, on the other hand, is inconsistent and fluctuates, that is because a variable APR is tied to an index- like the prime rate index, in the US. The prime rate is set to match the Federal funds rate established by the Federal Reserve, meaning that any time the Federal government changes interest rates throughout the country, variable APRs will change accordingly.