APR
BankingDefinition
Annual Percentage Rate is the stated annual cost of borrowing money, including fees but NOT including the effect of compounding. Because it ignores compounding, APR always understates the true cost of a loan.
When a credit card advertises "24% APR," the actual cost is higher because interest compounds monthly. The true cost (called EAR or APY) would be about 26.8%. Lenders are required by law (Truth in Lending Act) to disclose APR, which is why you see it on every loan offer - but it's designed to make borrowing look cheaper than it actually is.
For mortgages, APR includes origination fees and points spread over the loan term, making it slightly more useful for comparing loan offers. But for credit cards and student loans, always look at the EAR instead.
When a credit card advertises "24% APR," the actual cost is higher because interest compounds monthly. The true cost (called EAR or APY) would be about 26.8%. Lenders are required by law (Truth in Lending Act) to disclose APR, which is why you see it on every loan offer - but it's designed to make borrowing look cheaper than it actually is.
For mortgages, APR includes origination fees and points spread over the loan term, making it slightly more useful for comparing loan offers. But for credit cards and student loans, always look at the EAR instead.
How it works
Advertised (APR)
24.0%
Looks cheaper
Actual cost (EAR)
26.8%
What you really pay
Formula
APR = (fees + interest) / principal / years
EAR = (1 + APR/n)^n − 1
EAR = (1 + APR/n)^n − 1
Example
Credit card: 24% APR compounded monthly → true cost = (1 + 0.24/12)^12 − 1 = 26.82% EAR. That's almost 3 percentage points higher than the advertised rate. On a $10,000 balance, that's an extra $282/year in interest you didn't expect.