An annual percentage rate (APR) is the percentage cost of credit on an annual basis. Lenders are required by law to disclose the APR to borrowers. Consider this:
- The annual percentage rate (APR) may be different from the stated interest rate.
- APR is the total cost of credit to the consumer. APR combines the interest paid over the life of the loan and all fees that are paid up front. APR is commonly used to compare loan programs from different lenders in order to help consumers make a better-informed choice. (Note: Rules regarding fees that must be included in APR are different for mortgage loans than for auto loans and short-term loans.)
- Although APR is a great way to measure the total cost of a loan, the actual monthly payment amount is a function of the amount borrowed, the interest rate and the length of the loan.
Computing APR for loans of longer than a year requires some complicated mathematics. In these cases, it is easier to use an APR calculator like the one found here.
There are key pieces of information that consumers must have in order to compute the APR, whether using a calculator or not.
- Consumers must know the amount of credit to be received – that is, the amount of the loan. For example, if a person wants to borrow $3,000 to buy a used car, the amount financed is $3,000.
- Consumers must know the dollar amount the credit will cost – that is, the fees and interest charges associated with a loan. Examples of fees included when computing APR are loan-processing fees and underwriting fees. The loan-processing fee for the used car loan above is $50, and the interest rate is 7 percent. (Note: When using the APR calculator, it is not necessary to know the dollar amount in interest; knowing the interest rate is enough).
- Consumers must know the length of the loan, often referred to as the "term" of the loan. In the case of the car loan, the term is 24 months.
- Entering this information into the APR calculator tells us that this loan, with a stated interest rate of 7 percent, has an APR of 8.63791 percent.
- If another dealer offered a stated interest rate of 6 percent for a two-year loan but charged a $100 fee, the APR would be 9.24659 percent.
- Obviously, APR is as important a factor as the stated interest rate when loans are being compared. Even though the interest rate on the second loan is lower, the APR is higher because the fee is higher.
The interest being assessed on short-term loans of less than one year are often simply stated as a dollar amount rather than as an interest rate. The lender may say, "I'll lend you $200 for two weeks, with a $20 finance charge." The finance charge is a 10 percent interest rate being applied to the two-week loan.
Use the following steps to compute the annual percentage rate (APR) for a loan of less than one year. For example, calculate the APR for a consumer who borrows $500 for car repairs. The sum of the fees and interest charges is $50. The term of the loan is 21 days.
Divide the sum of the fees and interest charges by the amount financed.
Multiply the answer by the number of days in a year.
Divide the answer by the term of the loan in days.
Move the decimal point two places to the right and add a percent sign.
Remember that APR expresses the cost of the loan by incorporating not only the interest payment based on the stated interest rate but by also incorporating all upfront fees paid by the borrower.
Solve the following, calculate the APR. (Popup Calculator) Round answers to the nearest whole number.
Andrew borrowed $500 to repair his car. The finance (interest) charge on the loan was $25, and the term on the loan was 31 days. What was the APR for Andrew's loan?
Type Your Response Here
[($25/$500) x 365]/31 = 59%
The Annual Percentage Rate is the percentage cost of credit on an annual basis. It is the total cost of credit to the consumer and is intended to make it easier to compare loan options in order to help the consumer make better-informed choices. Notice that Andrew and Mario had the same interest charge and loan amount, only the term was different. Because the term of Andrew's loan is longer, he had a lower APR than Mario.
Have you ever used a short-term loan to obtain things you want? Remember that when fees and interest are combined for short-term loans, the APRs become very high.