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When you take out a loan or credit card, you'll receive a fixed or variable annual percentage rate (APR) that represents the total cost to borrow money. A fixed APR is a rate that remains the same for the entire loan term and is based on current market conditions at the time the loan is approved.
Fixed APRs differ from variable APRs, which are tied to an index such as the prime rate and can increase or decrease whenever the underlying index changes. Installment loans typically carry fixed APRs, while credit cards usually have variable APRs.
Because a fixed rate is more predictable, you'll know the total cost to pay off a loan upfront based on the APR. When shopping for financing, it's important to understand how fixed APRs work.
How Fixed APRs Work
Unlike an interest rate, which is simply the cost of borrowing the principal amount, an APR represents the total cost of borrowing money from a lender. With a mortgage, car loan, personal loan or another type of installment loan, the fixed APR calculation will include interest as well as any additional costs, such as loan origination and processing fees.
With credit cards, interest rate and APR are the same thing, but you only incur interest on balances not paid in full each month. Annual fees and other fees are not included in the APR calculation.
The fixed APR on an installment loan will not change. On the rare chance you have a credit card with a fixed APR, however, its rate could change under certain circumstances, such as if you miss a payment. Should a credit card's APR change, your lender must notify you 45 days in advance, and the higher rate will typically only apply to transactions made after the rate change.
Keep in mind that your monthly loan payment could change even if your APR is fixed. For instance, if your homeowners insurance, mortgage insurance or property taxes are included in your loan payment and increase or decrease, so might your monthly payments.
Pros and Cons of a Fixed APR
As with many financial products, fixed APRs have good and not-so-good points.
- The APR remains the same throughout the loan term.
- Because the rate is fixed, you know the total cost to pay off the loan.
- A fixed APR protects you from interest rate increases.
- If market rates drop, you won't benefit from the lower rate.
- Even with a fixed APR, your monthly payments can change.
- APRs can be higher than interest rates because of the added fees and other costs.
How to Save on Interest Charges
Interest adds to the total cost of borrowing. If the Federal Reserve raises interest rates, you'll face a higher cost of borrowing and monthly payments when you take out a loan. The good news is that you can take steps now to save on interest charges:
- Improve your credit. Generally, the higher your credit score, the better interest rate you'll qualify for with lenders. Paying down debt, controlling how much you spend and paying your bills on time are just some of the ways you can improve your credit.
- Pay your credit card balances in full each month. You only pay interest on balances not paid in full each month. By paying off your credit card balance, you can avoid interest charges and lower your credit card costs.
- Pay off loans early. Generally, the longer it takes to pay off your loan, the more you'll pay in interest. So paying off loans early makes sense. But before you take steps to repay your loan early, make sure your lender doesn't charge a prepayment penalty—a fee for paying off your loan before the end of the term.
- Set up autopay. By setting up autopay, you can be sure your payment will be made on time every month, saving you from unexpected interest charges.
- Consolidate high interest debt. Consolidating your debt has several advantages, including the possibility to pay less in interest over time.
- Shop around. Shopping around for the best rates on loans and credit cards can save you a tidy sum in interest over time. You might even consider reaching out to your credit card company to negotiate a lower interest rate.
The Bottom Line
Unlike a variable APR, a fixed APR does not change based on a benchmark rate. You know exactly what it will cost to pay off your loan at the onset, and if interest rates soar to new heights, you can rest easy knowing you're protected. Then again, if interest rates drop, your rate will remain the same.
Not sure you'll qualify for the best fixed APR? Get your FICO® Score☉ for free and see how you measure up to a lender.