Understanding Annual Percentage Rate (APR)
The banking costs of a loan involve more than just interest rates. When applying for a loan, it is common for lenders to charge fees or points in addition to interest. Instead of merely focusing on interest, borrowers should pay more attention to the annual percentage rate, or real APR, when considering the actual cost of a loan.
What is APR?
APR (Annual Percentage Rate) is a standardized way to show the total cost of borrowing money, expressed as a percentage. It includes not only the interest rate but also any fees or additional costs associated with the loan. This makes it easier to compare loan offers from different lenders.
Factors that Affect APR
- Interest Rate: The base cost of borrowing the money
- Origination Fees: Charges for processing the loan application
- Points: Prepaid interest that can lower your interest rate
- Loan Terms: The length of time you have to repay the loan
- Compounding Frequency: How often the interest compounds (daily, monthly, quarterly, annually)
- Other Fees: Application fees, closing costs, etc.
APR vs. Interest Rate
The interest rate is the percentage of the loan amount that the lender charges you to borrow money. The APR includes the interest rate plus other loan costs and fees.
For example, a mortgage with a 4% interest rate might have an APR of 4.25% when closing costs, points, and other fees are factored in. This means the true cost of the loan is higher than just the interest rate.
How to Use the APR Calculator
- Enter the loan amount you want to borrow
- Specify the loan term in years and months
- Enter the stated interest rate
- Select how often interest compounds
- Choose your repayment frequency
- Enter any fees that are included in the loan amount
- Enter any upfront fees paid out-of-pocket
- Click "Calculate APR" to see the real cost of your loan
Remember that a lower APR generally means a less expensive loan, but you should also consider factors like fixed vs. variable rates and the total loan term when making borrowing decisions.