What is the Annual Percentage Rate (APR)?

Published by Thomas Herold in Economics, Banking

'Annual Percentage Rate (APR)' is explained in detail and with examples in the Banking edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.

The annual percentage rate, or APR, is the actual interest rate that a loan charges each year. This single percentage number is truthfully used to represent the literal annual expense of using money over the life span of a given loan. Annual percentage rate not only covers interest charged, but can also be comprised of extra costs or fees that are attached to a given loan transaction.

Credit cards and loans commonly offer differing explanations for transaction fees, the structure of their interest rates, and any late fees that are assessed. The annual percentage rate provides an easy to understand formula for expressing to borrowers the real and actual percentage number of fees and interest so that they can measure these up against the rates that other possible lenders will charge them.

Annual percentage rate can include many different elements besides interest. With a nominal APR, it simply involves the rate of a given payment period multiplied out to the exact numbers of payment periods existing in a year. The effective APR is often referred to as the mathematically true rate of interest for a given year. Effective APR’s are commonly the fees charged plus the rate of compound interest.

On a home mortgage, effective annual percentage rates could factor in Private Mortgage Insurance, discount points, and even processing costs. Some hidden fees do not make their ways into an effective APR number. Because of this, you should always read the fine print surrounding an APR and the costs associated with a mortgage or loan. As an example of how an effective APR can be deceptive with mortgages, the one time fees that are charged in the front of a mortgage are commonly assumed to be divided over a loan’s long repayment period. If you only utilize the loan for a short time frame, then the APR number will be thrown off by this. An effective APR on a mortgage might look lower than it actually is when the loan will be paid off significantly earlier than the term of the loan.

The government created the concept of annual percentage rate to stop loan companies and credit cards issuers from deceiving consumers with fancy expressions of interest charges and fees. The law requires that all loan issuers and credit card companies have to demonstrate this annual percentage rate to all customers. This is so the consumers will obtain a fair comprehension of the true rates that are associated with their particular transactions. While credit card companies are in fact permitted to promote their monthly basis of interest rates, they still have to clearly show the actual annual percentage rate to their customers in advance of a contract or agreement being signed by the consumer.

Annual percentage rate is sometimes confused with annual percentage yield. This can be vastly different from the APR. Annual percentage yield includes calculations of compounded interest in its numbers.

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The term 'Annual Percentage Rate (APR)' is included in the Banking edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.