You probably don’t need to be told that your credit scores will have a considerable impact on the interest rates you are charged for financing, including for a mortgage loan. Bad credit typically means you pay more and good credit typically means you pay less. However, even if you understand this general concept, you may still have questions about the process. What exactly is an APR? How do your credit scores affect them? Why is it that you might be charged more for your loan than the next guy if you have credit problems?
What Is APR?
APR stands for Annual Percentage Rate. It represents the interest plus any other fees you will be charged, broken down on an annual basis. The Truth in Lending Act (TILA) made it a requirement for lenders to disclose the true cost of financing to you in the form of an APR. Prior to the TILA lenders were able to advertise loans with lower rates without disclosing additional costs and fees associated with the financing. The purpose of the APR disclosure requirement under the TILA is to hopefully give you a better idea of the total costs connected with the financing on a loan or credit card.
According to the Consumer Financial Protection Bureau (CFPB) an APR on a mortgage is "a broader measure of the cost to you of borrowing money."
On credit card accounts your interest rate and APR are typically the same thing. Yes, there can be additional fees on a credit card account (i.e. late fees, annual fees, etc.), but it is not possible for your card issuer to accurately predict which fees, if any, you will incur in advance. For this reason credit card issuers are required to create a "Schumer Box," which discloses the rates, fees and terms associated with credit cards. Additionally, credit cards are unique in the fact that you can typically avoid paying any interest at all as long as you pay off your balance in full by the due date each month.
APRs on mortgage loans work a bit differently. According to the Consumer Financial Protection Bureau (CFPB) an APR on a mortgage is "a broader measure of the cost to you of borrowing money." The CFPB goes on to say that "the APR reflects not only the interest rate but also any points, mortgage broker fees and other charges that you pay to get the loan." This explains why your APR is typically higher than your actual interest rate itself on a mortgage.
How Do Credit Scores Impact APRs?
Most lenders and credit card issuers charge different interest rates and fees (aka APRs) based on your credit worthiness. For example, a credit card issuer might advertise an APR range of 10.99 to 19.99 percent for approved borrowers. If you were to apply for a new credit card, the card issuer would check your credit report and credit score, assess your risk and either deny or approve your application. If approved, the card issuer would then set an APR within the advertised range, based upon your level of risk. This is referred to as setting the terms of the account.
If your goal is to land the best possible offers for any type of new financing, you will probably want to shoot for earning a FICO or VantageScore credit score of at least 760 or higher. Otherwise your loan or credit card application may be approved, but not necessarily with the best terms available. Earning and maintaining great credit will undoubtedly save you thousands of dollars in interest and financing fees over the course of a loan, especially on larger loans like mortgages. And since most of you will have a consumer credit lifecycle of over 50 years, the downside of having bad credit can be well into the six figures of wasted money.
How Do APRs Impact Credit Scores?
Warning: This is a trick question. Credit scores can certainly impact your APR, but your APR does not have any direct influence over your credit scores. In other words, if you have a high APR, that fact would not impact your credit scores in any way. Your credit reports do not list the APRs associated with any of your accounts.