Annual Percentage Rate (APR) - How it affects your payment

While talking about debt, we often come across the terms APR, closing costs, interest rates, etc. But people know very little or nothing on these topics. APR helps you determine your payment amount on a loan. It also plays a very crucial role in debt consolidation. Check out the following topics to know the various aspects of APR.

What Annual Percentage Rate is all about?

Annual Percentage Rate is a measure of the cost of credit, expressed as a nominal yearly rate. APR is the equivalent interest rate (considering all additional costs) charged on a certain loan amount. It is a function of the loan amount, interest rate, total additional cost, and the loan term.

For example, Sally takes out a loan from Bank of America.

The loan amount = $10,000

The monthly interest rate on the loan= 2%

The total loan term = 12 months

The total closing costs = $2000

So, after adding the additional costs to the interest rates, the annual percentage rate becomes = 45.559%

Thus, for a loan amount of $10,000 with 2% interest rate, the Annual Percentage Rate can be as much as 45.559%.

However, for more accurate calculation, you can use an APR calculator or APR interest calculator. The Annual Percentage Rate calculator will help you calculate APR correctly.

What are the fees included in APR?

The fees included within the APR vary from one lender to another. The fees included within the APR involve charges related to the making of the loan and other fees such as title fee, escrow fee, attorney fee, tax service fee, home inspection fee, recording fee and credit report fee. The fees for the preparation of loans include loan processing fee, underwriting fee, document preparation fee, private mortgage insurance, loan application fee, credit life insurance and appraisal fee.

What are the fees excluded in APR?

Check out the fees which are excluded from the calculation of APR:

  • One-time fees paid to a person apart from the lender.
  • Late fees and penalties.

How does APR help you?

Lenders often mislead borrowers by charging hidden fees. This is where the APR can come into help. It is used to compare the true cost of various loans and find out whether the creditor has included any hidden fee. Before going in for any loan, one should check the APR of that loan to have a clear picture about the amount he will be liable to pay back against the borrowed amount.

What is the difference between APR and interest rates?

The APR and the interest rate are different from each other. The APR takes into account extra costs along with the normal interest rate. These extra costs vary from one lender to another and hence the APR varies. However, in case of loans having no extra cost, the APR is same as the interest rate.

Is there any difference between APR and APY?

APR expresses the annual interest rate in terms of a percentage. It indicates the true cost of the funds over the loan term. Consumers are advised to compare the APR on the loans to determine which card will cost them most or least. However, shopping for a card solely on the basis of APR is not a good idea. This is because it does not consider the compounding interest in the year, which APY does.

APY is the abbreviation of Annual Percentage Yield. It primarily refers to the interest yield you'll earn on a financial product in a year. As it takes the compounding interests into account, so it gives a better measure of how much interest would actually cost.

The difference can be understood from the given formulae:

APR = Periodic Rate * Number of Periods in a Year
APY = (1 + Periodic Rate)^n 1 (Here n denotes the number of times you compound in a year. Basically, it refers to the compounding period).
For example, a credit card company charges 1% interest rate on a card per month. Then the Annual percentage rate on the credit card will be = 1% * 12 months = 12%. However, the APY on the credit card with 1% monthly compounding interest rate will be (1+ 0.02)^12 1 = 12.68% in a year.

Is there any law regarding APR?

In order to protect consumers from the tricks of lenders and clear their doubts on terms related to credit and rates, the FDIC enacted the Truth in Lending Law in 1968. Regulation Z. Part 226, under Truth in lending Act came into effect from July1, 1969. This section defines the Annual Percentage Rate (APR). By this law, a creditor is bound to disclose the APR to a borrower within three days of receipt of loan application. The creditor cannot hide the extra costs and is liable to reveal all the costs along with the interest rate to the borrower before signing any agreement. For further details, check FDIC.

APR is a very effective tool for protecting consumers against inaccurate and unfair credit billing and credit card practices. So if you are in debt and planning for debt consolidation, the APR is the best way to judge who can provide you with the best solution. Debt Consolidation not only makes you debt free but also reduces the APR to save a lot of money. So even when you are in serious debt problems, you end up saving with debt consolidation.