What Is APR?
When comparing different loans and lines of credit, consumers are usually interested in how much the credit or loan is going to cost them. The most important figure they look at to determine this is APR, which is short for the annual percentage rate.
APR is a key factor in assessing loans because it allows the borrower to know how much they will pay for their debt.
How It Works
Credit cards, mortgages, car loans, and personal loans all carry an annual percentage rate. The APR is essentially the interest rate plus any fees and hidden costs the loan may carry.
For example, take a credit card with an APR of 19.99%. If a borrower uses the card and pays off their balance every month, there is no extra cost. If they decide to carry a balance, then there would be a yearly cost associated with the debt, broken down into monthly payments. That cost would be 19.99% of the total outstanding amount.
The Formula And Calculation
Calculating the annual percentage rate can be done using the formula listed below.
(Fees + Total Interest Paid / loan amount) / Total Days In Loan) * 365] * 100 = annual percentage rate
Loan costs can often be deceiving. For example, a loan may have a lower interest but high fees, meaning the overall cost of the loan is much higher than what the interest rate would lead one to believe. For example, consider a loan for $2,000 with a term of 365 days. The loan carries $220 worth of interest plus a $35 origination fee.
- Add Origination Fee And Total Interest Paid: 220 + 35 = 255
- Divide Sum By Loan Amount: 255/2000 = 0.1275
- Divide Result By Term In Days: 0.1275/365 = 0.0003493
- Multiply Result By 365: 0.0003493 = 0.1275
- Multiply result by 100: 0.1275 * 100 = 12.75% APR
What Is Good APR For a Loan?
One of the most common questions people ask is “what is a good APR for a loan”? This question depends on several factors, such as debt type and credit score. A credit card will usually carry a higher rate than personal loans and lines of credit.
Those with good credit may be able to secure a card with a rate of around 15%, whereas the average credit card rate is usually around 19%. When it comes to lines of credit, the average rate is around 12%, meaning anything below that can be considered a very good rate.
APR Vs Interest Rate
Interest refers to the percentage charged by the lender on the principle of the loan and this does not include any fees or hidden costs that the borrower may be subject to. The annual percentage rate is a representation of the interest plus all associated fees and gives a better understanding of the overall yearly cost of a loan.
For example, a $1,000 loan with a year term may have an interest rate of 10% but an origination fee of $75. This would mean the total cost of the loan would be $1,175, which would make the annual percentage rate 11.75%
Fixed vs Variable APR - What Is The Difference?
- Fixed-Rate: A loan in which the annual percentage rate stays the same for the duration of the loan.
- Variable Rate: A loan that carries an APR rate that fluctuates with market conditions. Should the market go up, the rates will rise accordingly. The reverse is also true.
Variable rates can have a major impact on the overall cost of a loan. A 1.50% change in the rate on a $50,000 loan can increase or decrease the overall cost by $750.
The Limitations Of APR
The rate listed on a loan does not always tell the full story and consumers must understand what to look out for when comparing loans.
- Not All Fees Are Included: Some fees, such as appraisal costs and inspection fees, are not always factored into the rate.
- Bait And Switch: Lenders will often advertise the lowest possible rate knowing that very few people will qualify for those rates.
- Assumes Long Term Loan: Mortgages of 30 years usually have higher upfront fees that factor into the overall rate. If one plans on refinancing their home, the lowest annual percentage rate may not be the best deal in the long run.
Those shopping around for a line of credit, credit card, or mortgage need to understand what a loan’s annual percentage rate is telling them. Understanding this will allow them to make the best possible choice when it comes to what debts to take or the actual cost of consolidating outstanding debts.