What is APR?

APR, short for annual percentage rate, is the yearly cost of borrowing money expressed as a percentage of what you owe. On a credit card it is the same number as the interest rate; on a mortgage it also folds in certain lender fees, making it a broader measure of cost. Either way, APR is the input that most determines how much interest a balance generates over time.

APR versus interest rate

The interest rate is the price a lender charges for the money itself, stated as a yearly percentage. The APR starts from that rate and, depending on the type of credit, may add other costs of getting the loan so that borrowers can compare offers on a more complete basis.

For credit cards, the two terms are effectively interchangeable: issuers quote the interest rate as an APR, so an 18% APR card charges interest at an 18% yearly rate. Annual fees and late fees are charged separately. For mortgages and many installment loans, the APR is deliberately different. It reflects the interest rate plus points, origination charges and certain other fees spread across the loan term, which is why the APR on a loan estimate is almost always a little higher than the rate.

How a monthly interest charge is derived

An APR is a yearly figure, but interest is charged more often than once a year. The simplest conversion is to divide the APR by 12 and apply that monthly rate to the balance. This is what the debt payoff calculator does: each month it takes the balance at the start of the month, multiplies by the APR, divides by 1,200 (12 months times 100 to convert the percentage), and rounds to the nearest cent before applying your payment.

Interest = Balance × (APR ÷ 100) ÷ 12

In practice, most credit card issuers use a daily periodic rate instead. They divide the APR by 365 (some use 360), multiply that daily rate by each day's balance across the billing cycle, and add the results together. Because cycles run 28 to 31 days and the balance changes as purchases and payments post, the statement charge drifts a little above or below the monthly estimate. On a steady $5,000 balance at 18% APR, the daily method produces roughly $74 in a 30-day cycle and roughly $76 in a 31-day cycle, compared with $75 from dividing by 12. Over the life of a debt the gap is small, but individual months will not match a statement to the cent.

Interest is charged on the whole balance, which is why a payment barely above the interest charge makes almost no progress: the balance stays nearly as large next month, so the interest does too.

A worked example: $5,000 at 18% APR

Suppose you carry a $5,000 credit card balance at 18% APR and pay a fixed $150 minimum each month. Here is how the first two months look under the calculator's assumptions.

In month one, $5,000 × 18 ÷ 1,200 is exactly $75.00 of interest, so only $75 of the $150 payment reduces the balance. In month two the balance is slightly smaller, so interest falls to about $73.88 and a bit more of the payment goes to principal. That pattern continues, with the interest share shrinking every month.

Carried through, the estimate says the $150 payment clears the balance in about 47 months, or 3 years 11 months, with approximately $1,984 of interest, based on the assumptions entered. Raising the payment to $350, an additional monthly payment of $200, is estimated to clear the same balance in about 17 months for roughly $670 of interest. The APR did not change; the payment did, and the interest bill fell by about two thirds because the balance the APR applies to shrinks much faster.

What changes the outcome

Three things determine how much interest an APR costs you: the size of the balance, how long you carry it, and the APR itself. Two of the three respond to payment behavior, which is why the scenario comparison often shows a bigger effect from an additional monthly payment than from a modest change in rate. Several features of real credit products also change the picture:

• Variable APRs. Many card APRs are set as a margin above a published reference rate and move when that rate moves. If the reference rate rises by a percentage point, your APR typically rises by the same amount, and the monthly charge on an unchanged balance rises in step. Federal rules limit increases on existing balances and usually require advance notice, but adjustments tied to a reference rate are an allowed exception.
• Promotional and penalty APRs. A 0% introductory APR charges no interest during the promotional window, then reverts to the regular rate; a penalty APR may apply after a late payment. The calculator assumes one constant APR per debt, so consider a second scenario with the post-promotion rate if you will not be finished before it ends.

APR on mortgages includes fees

On a mortgage, the interest rate determines the monthly principal and interest (P&I) payment. The APR adds points, origination and certain other fees, then expresses the total as a yearly rate over the full term, so it is generally higher than the rate.

That makes the mortgage APR useful for comparing loans with different fee structures over their full terms, but it assumes you keep the loan for the entire term; if you sell or refinance early, up-front fees are spread over fewer years and the effective cost is higher than the APR suggests. It also says nothing about property taxes, insurance or PMI, which are part of your total monthly housing payment but not part of the loan's cost of credit.

For the debt payoff calculator the distinction is practical: enter the interest rate for a mortgage or auto loan, because that is the rate applied to the balance each month, and enter the APR for a credit card, where the two are the same.

Why APR drives the debt avalanche order

The debt avalanche pays minimums on everything, then directs every additional dollar to the debt with the highest APR, working down the list as each is retired. The reason is arithmetic: a dollar at 26.99% APR costs more than twice as much interest each month as a dollar at 12%, so retiring the high-APR dollar first removes more interest from next month's bill.

The calculator's reference example shows the size of the effect. Take a credit card with $8,000 at 22.99% and a $240 minimum, an auto loan with $12,000 at 6.5% and a $350 minimum, and a store card with $2,500 at 26.99% and a $75 minimum. With $300 of additional monthly payment, the avalanche order (store card, credit card, auto loan) is estimated to clear everything in about 27 months with approximately $3,525 of interest. Starting with the lowest-APR auto loan instead is estimated at about 29 months and roughly $5,201 of interest on the same budget; minimum payments alone at about 63 months and roughly $8,354.

The avalanche versus snowball comparison walks through when a different order might still be worth some extra interest. The point here is simpler: because APR sets the monthly cost of each balance, it is the number the avalanche sorts by.

Common mistakes and misconceptions

• Treating APR as a monthly rate. An 18% APR does not take 18% of your balance every month; it takes about 1.5%. The reverse mistake, thinking 1.5% a month is small, is just as common: on a balance that is not shrinking, that is the full 18% a year.
• Assuming the minimum payment mostly goes to principal. In the example above, half of the first $150 payment was interest. If your minimum is close to the monthly interest charge, very little is reducing the debt; if it is below the interest, the balance grows. Our article on minimum payments shows how to spot that.
• Comparing a mortgage APR to a credit card APR. One includes fees spread over 30 years; the other is a bare interest rate. Compare rate to rate and APR to APR within the same product type.
• Focusing on APR while ignoring the balance. A 29% APR on a $300 balance costs about $7 a month; a 7% APR on a $20,000 balance costs about $117. For the fuller mechanics, see how credit card interest works.

APR (annual percentage rate)

The yearly cost of borrowing as a percentage of the balance. For credit cards it equals the interest rate; for mortgages it also includes points and certain fees.

Periodic rate

The APR divided across the period interest is charged for: APR ÷ 12 monthly, or APR ÷ 365 daily.

Variable APR

An APR set as a fixed margin above a published reference rate, so it rises and falls when that rate changes.

Debt avalanche

A payoff order that pays minimums on every debt and sends all additional money to the debt with the highest APR first.

Try it with your own numbers

Enter each of your debts with its balance, APR and minimum payment, choose the debt avalanche order, and compare the estimated interest and payoff date against a minimum-payments-only baseline. Then raise the APR on your largest card in a second scenario to see how much the total moves. All figures are estimates based on the assumptions entered.