What is APR? Understanding How APR Is Calculated

When opting for a loan or going ahead with an investment, you may come across a term called the Annual Percentage Rate or APR which is often confused with the annual interest rate. Let’s know what is APR and how it affects your loan.

You may have seen the advice to check the APR offered on a loan and choose from different loans with the least APR. Let us, therefore, look at what the Annual Percentage Rate is and how you can decrease the cost of your loan by choosing the best APR on offer.

The Annual Percentage Rate is the annual rate charged by a lending bank or a financial company when you borrow a loan or earn via an investment. It is effectively the interest that a lender is charging on a loan in a year. The Annual Percentage Rate is expressed as a percentage of the borrowed amount and the borrower is required to pay the APR along with the principal amount. The APR is basically the method to compute the total cost of a loan that you incur in a year. It includes the annual interest rate, processing fees, penalties, and other charges applicable to the loan.Many times, the APR is confused with the nominal interest rate. While the APR does include the nominal interest rate, it also includes other fees applicable on the loan. It is, thus, a combination of the annual interest rate and other charges on a loan. Hence, the APR is always higher than the nominal interest rate on a loan.

The APR is a good barometer to check the cost of a loan. For example, if you’re borrowing a personal loan , and you want to see how much the loan would cost you, then you need to look at the Annual Percentage Rate, since this is the amount you would be paying in addition to the principal amount.Hence it is a good idea to not just rely on the annual interest rate, since that only tells you the interest component. The APR includes all other charges and hence is a much better way to calculate the cost of a loan.Lenders sometimes lure borrowers by advertising less annual interest rates but the additional charges may be hefty. The APR gives you the exact percentage of all charges on loan and you’re in a better position to understand how much the loan would cost you.

Banks or lenders may levy different types of APRs on different products. Loans, for example, may have a fixed APR or a variable APR. A fixed APR has an interest rate that will remain the same throughout the loan tenure, whereas a variable APR loan will have a fluctuating interest rate.Similarly, APRs for credits may be different for card purchases, cash advances and balance transfers. Late payments on credit cards could also attract a higher APR.

The biggest benefit of APR is that it gives a good understanding of the cost of loan to the borrower. You can compare various loan offers by comparing the APR and find out who is offering the cheapest and most competitive loan. Since the APR includes all fees in a loan, it gives the best idea of how much you would have to pay for the loan.

• Since different lenders have different terms, charges, repayment structures etc, it can get cumbersome to compare loans since you cannot always go through all the tiny details of multiple loan offers. In this scenario, the APR gives a standardized figure that you can directly compare among lenders and make the best choice.
• The APR gives you an insight into the exact cost of your loan and hence you can gauge your repayment ability and plan it accordingly.

The APR depends on a lot of factors like the repo rate offered by the RBI, the borrower’s credit score, and other features of a loan. There is no set APR which is considered good. The goal must be to get a balance of an economical APR and loan features and benefits.

The basic formula to calculate the APR of any loan is as follows:

APR= [{(Fees + Interest)/ Principal}/ n]*365*100

Where:Interest = Total interest paid over life of the loanPrincipal = Loan amountn = Number of days in loan termYou can also easily find out the APR by using an APR calculator on the lender’s website. Simply input the details like rate of interest, other charges, loan amount and tenure into the calculator and it will give out the APR.

The APR is, thus, an important number when choosing your loan. It gives you the exact idea of the loan cost and you can plan your repayment accordingly. It is also highly useful when comparing loans as you can choose the most economical loan based on the APR. So make sure you calculate the APR of the loan so you can choose the best loan on offer.

The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.