Annual Percentage Rate (APR)
Definition:
The Annual Percentage Rate (APR) is the yearly interest rate charged for borrowing or earned through an investment, expressed as a percentage. APR includes both the nominal interest rate and any additional fees or costs associated with the loan or credit. It is a standard way of comparing different loan offers because it reflects the total cost of borrowing over a year.
Example:
If you borrow $10,000 at an interest rate of 5% for a year, and there are additional fees of $200, the APR would include both the interest and the fees, giving you a clearer picture of the true cost of the loan.
Loan Amount: $10,000
Interest Rate: 5% annually
Fees: $200
In this case, the APR will be higher than 5% because it includes the $200 in fees, which would be factored into the overall cost of the loan.
Formula to Calculate APR:
To calculate APR, use the following formula:
APR = [(Interest + Fees) / Loan Amount] × (365 / Loan Term in Days) × 100
Where:
Interest = The amount of interest paid on the loan.
Fees = Any additional fees associated with the loan (e.g., origination fees, processing fees).
Loan Amount = The principal or amount borrowed.
Loan Term in Days = The number of days in the loan term.
Why APR is Important:
Transparency: APR provides a clearer picture of the cost of a loan by including both the interest rate and any fees, which makes it easier to compare different loan offers.
Comparison Tool: When comparing loans or credit cards, the APR is an important metric because it represents the total cost of borrowing.
Understanding Total Costs: By considering APR, borrowers can see beyond just the interest rate and understand the full cost, helping them make more informed decisions.
Key Takeaways:
APR includes both interest and fees associated with borrowing, which helps you compare different loans and credit offers.
It reflects the total yearly cost of borrowing, including any additional charges.
APR is especially useful when comparing loans of different terms, as it standardizes the cost across various offers.