APR stands for Annual Percentage Rate and is the amount the borrower is charged yearly over the term of the loan. Its most common use is found in credit card charges. However, this term also applies to annual rates earned through investment. Intuitively, APR = U.S. prime rate + margin rate established by the lending institution.
APR does not take into account compound interest. Borrowers use annual percentage yield (APY) in analyzing compounded rates.
Comparing APR And Interest Rates
Truly, interest rates and APR’s are very similar. However, they vary in ways that sometimes confuse borrowers. For example, interest rates are strictly the interest charged on the amount borrowed. This excludes other costs such as fees associated with receiving the loan.
Consequently, APR is typically higher than a loan’s nominal interest rate. Consider closing costs of a buying a house, or even mortgage insurance. Adding these cost to the original loan yields a new loan amount. A borrower now pays annual interest on the principle plus the additional fees. This new annual payment divided by the original loan amount tells borrowers their APR.
How APR Affects You
Lenders typically do not change this rate within the first 12 months of the loan. It is important to note preset times that the lenders change financing terms. Furthermore, companies usually offer a grace period for payment. If a borrower pays the balance of the loan each month, he does not pay interest.
Additionally, the interest charges increase inherently as the amount owed increases. For this reason, it is important to pay as much of the loan each month as possible. The loan charges will increase exponentially, causing the borrower to pay unnecessary charges.
In conclusion, APR tells borrowers the rate at which lenders charge for the loan. It gives a better understanding of the cost of the loan. This measure gives a ballpark starting point, telling borrowers the most basic terms of the loan.