What is the Annual Percentage Rate (APR)?

It is the total cost that a lender charges on loan for a year. One can calculate the APR as a percentage of the loan amount. The borrower must pay the APR in addition to the principal. It comprises the nominal interest rate and other expenses associated with the loan.

Key Takeaways

  • The annual percentage rate is the rate charged by the lender on the borrowed amount or investment over a year.It is the cost of credit or borrowing, as it reveals the number of loans individuals shall repay at the end of the tenure.APR is not the same as interest rates. It is broader than interest rates as it includes interest rates along with fees, mortgage brokerage, and other charges.It is of two different types: fixed and variable APR. Fixed APR does not respond to changes in the index, whereas variable APR changes with the index interest rates.

APR Explained

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An annual percentage rate is the rate charged on loan or earned on an investment over a year. It is, in simpler words, a measure of the cost of credit or the borrowing expense represented as a percentage amount every year. APR includes Interest and any fees related to the transaction. The interest rate per payment period is multiplied by the number of payment periods in a year to arrive at this number. The figure accurately reflects the genuine, objective, and exact cost of borrowing money. It is a word associated with loans, mortgagesMortgagesA mortgage loan is an agreement that gives the lender the right to forfeit the mortgaged property or assets in case of failure to repay the borrowed sum and interest.read more, and investmentsInvestmentsInvestments are typically assets bought at present with the expectation of higher returns in the future. Its consumption is foregone now for benefits that investors can reap from it later.read more.

The annual percentage rate on mortgage charges includes loan points, loan origination fees, property inspection fees, mortgage insurance premiums, mortgage brokerMortgage BrokerA mortgage broker is an intermediary that liaisons between the mortgage borrower and mortgage lender. Such brokers are responsible for gathering information, documentation process concerning income earned, an asset owned, credit report, and employment details to assess the borrower’s ability to secure financing.read more fees if any, and other loan transaction costs. These charges are levied in addition to the payment of Interest. Since interest rates are not inclusive of the above charges, it is lower than APR. With the above expenses deducted, the money received will be less than the requested amount. APR can be thought of as the rate of returnRate Of ReturnRate of Return (ROR) refers to the expected return on investment (gain or loss) & it is expressed as a percentage. You can calculate this by, ROR = {(Current Investment Value – Original Investment Value)/Original Investment Value} * 100read more on a loan, considering the costs involved. Similarly, the interest rates on credit cards are usually expressed as an annual rate. This is referred to as the annual percentage rate on credit cards. If individuals pay their balance in full each month by the due date on most cards, they can avoid incurring Interest on purchases. This way, individuals can reduce the annual percentage rate on credit cards. 

Annual Percentage Rate Formula

There are many online calculators to calculate annual percentage rates but the general formula to calculate annual percentage rates is as follows:

Formula to calculate annual percentage rate:

APR = ((Interest + Fees / Principal or Loan amount) / N)) x 365 x 100

Where,

  • Interest = the total number of payments made in installments spanning the loan period. The principal is the actual amount a person borrows. They have to pay it at the end of the borrowing. N = the number of days in the loan term. Fees can equal other charges such as transaction costsTransaction CostsTransaction cost is the expense one incurs by engaging in economic exchange of any kind. Any activities associated with a market generate transactional costs. They represent the trade expenses that one needs to cover for aiding the trade of goods and services in a market.read more or brokerage feesBrokerage FeesA brokerage fee refers to the remuneration or commission a broker obtains for providing services and executing transactions based on client requirements. It is usually charged as a percentage of the transaction amount.read more.

APR Calculation Example

Let us look at an annual percentage rate example since it gives readers a basic idea about APR.

Dave wants to apply for a mortgage loan for $500,000 With a repayment tenure of 5 years. The Interest the bank charge (7%), a fee of 1.5%, insurance costs, etc., amount to $5000. The calculation of APR is as follows:

The total fee, including the insurance cost, is $12,500 ($5000+7500). The annual interest rate is $175000 (5000007/1005).

Therefore, APR = [(12500+175000)/500000/1825365100] = 7.5% 

The actual cost of the loanLoanA loan is a vehicle for credit in which a lender will give a sum of money to a borrower or borrowing entity in exchange for future repayment.read more is 7.5% for five years. Dave’s total expenditure on his borrowing is 0.5% higher than the nominal interest rateNominal Interest RateNominal Interest rate refers to the interest rate without the adjustment of inflation. It is a short term interest rate which is used by the central banks to issue loans.read more.

Types of APR

In general, there are two types of APR – Fixed and variable. A fixed APR differs from a variable APR in that it does not alter in response to the changes in an index. This does not necessarily mean that the interest rate will never change, but it does mean that the issuer must notify the public before the rate changes. A variable-rate APR, also known as a variable APR, fluctuates following the index interest rate.

APR is generally a good measure to check the cost of a loan. For example, taking a personal loan can be taxing with high-interest rates. If the loan is for a large amount, it is better to check how much it would cost and then decide to opt for it or not. This is because the person has to pay APR in addition to the principal amountPrincipal AmountLoan Principal Amount refers to the amount which is actually given as the loan from the lender of the money to its borrower and it is the amount on which the interest is charged by the lender of the money from the borrower for the use of its money.read more. Lenders sometimes attract borrowers by advertising low-interest rates, but the additional charges levied may be heavy on an individual’s pocket. This is sometimes especially true in the case of annual percentage rates on mortgages.

This has been a guide to Annual Percentage Rate and its definition. Here we discuss how APR works along with its formula, types, and calculation example. You can learn more from the following articles –

APR is calculated considering the interests paid, the tenure of the loan taken, and other charges. In addition, they include fees, loan points, and other related charges.

APR can be found with the formula, APR = ((Interest + Fees / Principal or Loan amount) / N or Number of days in loan term)) x 365 x 100.

No, APR is broader than the interest rate. Interest rates are those that have to be paid in regular monthly installments. On the other hand, APR includes interest rates, fees, loan points, brokerage, etc. Therefore, it is usually higher than the interest rates.

They are important as they help in knowing the cost of borrowing a loan. It can help individuals decide whether or not a particular loan is affordable for them. APR helps compare various loan options, and these underlying charges are what make loans expensive.

  • APR vs APYAPR vs Interest RateVariable Interest Rate