What Does APR Mean and How Is It Calculated?

Published January 7, 2013 by

When you apply for a loan, the lender is required to tell you the loan’s APR. But what exactly is the APR? This term stands for “annual percentage rate,” and it refers to the interest rate on a loan for the entire year, rather than just a monthly rate. This number can affect how much you will have to pay in interest charges per year if you don’t repay your loan balance in full.

How Does the APR Work?

If you have ever applied for a loan or a credit card, you’ve probably seem the term “APR” littered throughout the application documents, but you may not really understand what the APR represents and how it is calculated. It is critical, however, that you do gain an understanding of this so you can make more informed decisions about whether or not to accept credit card or loan offers that you may receive.

The APR is a numeric representation of your interest rate. When you are shopping for the best credit card and looking at a number of different options, this number can help you determine how expensive a transaction will be on each card. Without the APR, it would be easy for lenders to hide the true costs of their offers. For consumers who want to borrow money, the APR is a useful tool that allows them to compare two or more credit cards or loans from different banks on a like-for-like basis.

APR: the Official Rate for Borrowing

The APR is meant to give you the overall equivalent cost of a debt. This number will vary from one lender to another. However, there are a few things that you have to watch for when discussing the rate with a particular lender. First, the APR doesn’t make sense with changing rates. Secondly, you won’t necessarily get the advertised APR. Where the term “representative APR” is used, it means that only 51 percent of applicants will receive the advertised interest rate. The rest of them will get higher rates.

Another disadvantage of the APR is that it takes into account all potential charges and fees even if you are never going to pay these on your account. It works best if you are comparing similar types of credit over similar periods. Even though it won’t tell you how much you will end up paying back, it can help you compare multiple credit cards to find out which one is right for you.

How Is the APR Calculated?

The APR takes into account interest charged as well as any additional fees that you will have to pay. It also considers when the interest is charged (daily, weekly, monthly or yearly), as well as initial fees and and other costs applicable to the loan. All banks have to calculate APR the same way, which enables customers to make an in-depth comparison between different credit cards, loans or mortgages.

According to the Office of Fair Trading, the APR is based on the total charge for credit, which includes interest and other fees that affect the cost of borrowing. The calculation is actually more complicated than it seems. This number must be included in all credit agreements and financial advertisements. Its purpose is to make it easier for consumers to compare the real cost of borrowing.