APR stands for Annual Percentage Rate, which tells you how much it costs to borrow money for a year. It includes interest and fees, so it helps you understand the true cost of borrowing and makes it easier to compare different loans or credit cards.
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This video explains the fundamentals of credit, distinguishing between its use for investments versus consumption. It highlights the risks of unsustainable spending and explains how the Annual Percentage Rate (APR) serves as a standardized measure to determine the true cost of borrowing money.
Let's talk a little bit about credit,
and in particular, how much you pay for credit.
So just as a reminder,
credit is essentially the ability
or when you actually borrow from someone else.
It could take the form of a mortgage
where you say you're borrowing money to buy a house,
or it could take the form of a credit card
where when you purchase things with that credit card,
you are borrowing money from the bank issuer
in order to purchase whatever you want.
Now, credit can be useful.
It could be convenient in the case of a credit card
where you don't have to carry cash around.
Some places only accept credit or a credit card,
and it can help you sometimes make good investments.
For example, if you borrow money
in order to make an investment
that's going to return more money than you put in,
but you have to be careful.
There's always some risk involved.
That actually could be a good financial decision.
Now, we also have to be very, very, very careful,
especially if you're using credit to buy something
that isn't an investment,
that's really just all about consumption.
Hey, there's a new outfit I want.
I'm going to use credit for it.
Maybe you're using it for the convenience
and you're going to pay off the balance
at the end of the month,
but if you're using it
because you actually don't have the money,
that is a bad sign.
That is a sign that you are spending more money
than you are bringing in,
and you're using credit to kinda not notice that.
And the reason why that's a big deal
is one, you're spending unsustainably,
but the other issue is there's usually
a pretty significant cost, especially to credit cards.
All credit, someone's going to charge you interest
for the amount that you borrow,
and there's usually going to be some fees on top of that.
And one way to think about the cost of credit,
you'll see something called APR.
These are annual percentage rate.
And what they do in the case of a credit card,
they look at your average daily balance,
and they're gonna charge you a certain amount of interest
plus fees on that average daily balance.
Now, if you were to just keep that balance all year,
you would actually have to compound
that average daily balance by 365 days.
But to simplify the calculation,
APR just takes how much interest you would pay times 365.
So it actually understates a little bit.
It's actually the interest plus the fees you would pay
as a percentage times 365,
which actually understates a little bit
what you would pay if you actually had to compound.
But it's a good standardized measure
of roughly what you're going to pay for a loan.
It's not uncommon for a credit card APR
to be in the high teens or even in the 20s.
In some cases, I've even seen them in the 30% range.
That is a lot of, that's a lot of expense
to pay to borrow money,
especially if you're not using it for investments.
Mortgages will also have APRs,
although they will be significantly lower,
mainly because the people lending to you
view that as a safer bet from their point of view.
And even when you're using a credit
for what you think are investments,
you have to be very conscientious of risk
because credit is really a way of getting leverage,
and we can talk more about that in other videos.
It can magnify how much you make
if, say, the asset increases in value,
but it can also magnify how much you lose
if the asset decreases in value.
We'll talk about that at other times.
But generally speaking, be very careful about credit,
especially if you're using it to buy,
if you're using it to consume versus invest.
And look at that APR.
It's a standardized way of really getting a sense
of how costly that loan is.
