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Annual Percentage Rate or
APR is a yearly rate of interest that includes
all of the fees and expenses paid to acquire the
loan or
credit card. APR can vary anywhere from around
3% right up to 21% and beyond.
APR for Loans:
APR is a standardized expression of the
interest rate that applies to a loan or credit
card, taking into account at least some of the
one-time fees that are applied by the lender.
There are several ways to calculate APR, but the
process generally includes 3 main steps. Firstly,
all one-time costs are added onto the loan amount.
Next, the monthly repayment for the loan is
calculated based on the loan's specified interest
rate. Finally, the interest rate, that would have
to be applied to the full loan amount in order for
its repayments to equal the calculated monthly
repayment, is calculated.
To see this in action, consider the following
simplified example where you borrow $1,000 and
there is a loan
setup fee of $50, making the total amount
borrowed $1m050. If the interest rate is 10%
(compounding monthly) and the term of the loan is
12 months, then you will need monthly repayments
of $92.32 to pay off the $1,050. However, a for
the monthly payment of a 12 month, $1,000 loan to
be $92.32 would require an interest rate of
19.32%. So, the APR is 19,32%. If the term of the
loan was longer, for example the loan was for 10
years instead of 12 months, then the loan fees
would be spread across this period, and the APR
would drop significantly.
The aim of using APR is to calculate a total cost
of borrowing, and to make the interest
understandable to an average consumer, so that
they can compare loans to determine the best deal
and also understand the loans that they already
have.
Unfortunately, despite repeated attempts by
regulators to establish a single standard for the
calculation of APR, it does not always represent
the total cost of borrowing nor does it really
create a standard that allows consumers to
precisely compare the costs of a loan.
The main issues in the calculation of APR arise
because the definition for the calculation of APR
does not specify which one-time fees must be
included and which can be excluded. For example,
should APR take into account fees and commissions
that are paid to someone other than the lender ?
Should APR include penalties, such as late fees ?
As a result, it is partly up to the lender to
determine which fees are included (or not) in the
calculation of APR.
In addition, APR is also highly dependent on the
term of the loan. For example, the APR for a loan
with a 25 year duration cannot easily be compared
to the APR for another loan with a 15 year
duration.
APR for Credit Cards:
For
credit cards the APR is a much simpler
calculation. Due to the fact that the amount of
money borrowed really isn’t known, you can not use
the formula that is used for most loans. It’s
simply a calculation of what the effective
interest rate is for one year when you take into
account that the interest is compounded monthly.
The formula for this is apr=(interest/12 + 1)^12.
So for a card with a 10% interest rate it would be
apr=(0.1%/12)^12, which is apr=1.0083^12, so apr=1.104
or approximated 11%. Really you should never have
to calculate this yourself though.
The APR on a credit card or loan can vary
depending on your loan history and credit risk.
For example, if you are applying for your first
card or have a poor
credit history, then the chances are that your
APR will be much higher than a seasoned borrower
with a good credit history.
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