Annual Percentage Rate (APR): What is it and what does it mean?

Before taking out a loan, many consumers look at the interest rate. However, this practice is not as effective as it is believed. And it is that a credit at an attractive rate is not necessarily the best in the financial market. Remember that loans and lines of credit may be subject to other costs, such as fees and related commissions. A better way to know how good a loan is is to look at the APR.

The APR allows that anyone will be able to discover with a fairly high degree of certainty how much they will pay in total for interest, fees and commissions.

But what is the APR and what does it mean?

The annual percentage rate (APR or Annual Percentage Rate) is, in a nutshell, how much does it cost to borrow an amount of money from the bank or a lender. With the exception of credit cards (where the interest rate and the APR are the same) the APR takes into account factors other than interest. For example, most banks usually include in their APR the collection of annual fees, initial commissions, collection expenses, among others.

Therefore, the APR gives a more accurate amount, allowing consumers to compare two, three or more mortgage loans, personal loans or secured loans to choose the cheapest option.

What fees are usually included in the APR?

The fees and commissions included in the APR essentially depend on the type of loan you want to apply for. Despite the vagueness of this statement, there are ways to find out what fees and commissions the bank considered when calculating the annual percentage rate it shows to its customers.

The first way is ask the bank agent directly. Representatives of financial institutions are required to answer common questions and concerns from customers. The second is by going to the “fees and commissions” section of the bank’s official website. Most banks have a descriptive section published on their website detailing not only the fees and commissions included in the APR of each loan or line of credit, but also the calculation method (360 days or 365 days). , for example).

And the third way is reading the contract of adhesion before signing it. Banking institutions must include by law the APR fees and commissions within the loan contract, as well as any other important information, such as the payment term, interest on arrears, penalties, etc.

Why is it important to analyze in the APR?

The APR analysis is the simplest method to find out how much debt you will have before taking out a loan or line of credit because it encompasses the total cost of future debt.

For example, if you request a loan of $10,000 payable in 180 days, the APR will include the total sum of the installments that will be paid to the principal, the interest generated on the basis of the loan, the collection expenses, the collection of the initial fee ( if any), among others.

Thus, you will have an estimated amount quite close to what you would end up paying at the end of the payment termOf course, as long as you pay all the loan installments on time.

In what types of financial instruments can you find the APR?

You are likely to come across APR at different stages of your life. Mainly, you will be able to see it in most bank loans, such as loans for vehicle purchases, mortgage loans and personal loans.

However, you must be careful: some types of loans have more than one APR. For example, when you receive a new credit card offer in your email, different APRs are listed:

  1. Penalty APR.
  2. APR to request cash advances.
  3. APR for physical or online purchases and payments.
  4. APR for balance transfer between cards.

Our recommendation? Before signing any contract (or accepting a new credit card) It is important that you make sure if it has an APR or several. Calculate and compare each of them with other financial instruments on the market and thus you will know how beneficial it is for you to accept or not that offer.

Formula to calculate the APR easily and quickly

Although it may seem difficult at first glance, calculating the APR is quite simple. You will only have to identify the fees and commissions associated with the loan, the interest rate, the amount of the loan and its duration, that is, the term that the bank will grant you to pay the debt. To help you, we will let you the APR formula. Thus, you can calculate yourself the APRs of the financial instruments in which you are interested. In case your loan does not have associated fees -something that is very rare to find- you can replace it in the formula with a zero.

[{(Tarifas + monto total de intereses / capital del préstamo) / plazo del préstamo en días} x 365 ] x100

Let’s see how the formula is applied taking into consideration the same previous example. Suppose you request a loan of $10,000 payable in 180 days and that the total amount of interest is $750. In addition, the bank will charge you an application fee equivalent to $25 and a 3% collection fee ($300). Then:

  1. First, add the interest ($750) with the fees and commissions ($300 + $25) = $1,075.
  2. Now, divide the result by the loan amount, $10,000 = 0.1075
  3. To continue, divide the quotient by the term of the loan in days (180) = 0.00059722
  4. Multiply the result by 365 days = 0.2179
  5. To finish, multiply 0.2179 by 100 to get the percentage = 21.79%

In the example, the APR of your loan will be 21.79%, which means that you will end up paying about $12,179.80 between capital, interest, commissions and fees. What does this mean? That requesting $10,000 from that bank through the financial instrument that it is offering you will cost $2,179.80 in your pocket.

Are there different types of APRs?

Actually yes. In most cases, the APRs are divided into fixed and variable. Let’s see what this is about:

  • Fixed APR. It means that the APR will not vary during the term of the loan or, what is the same, that it is not subject to a specific index. Therefore, calculating in fixed APR is much more accurate.
  • Variable APR. As the name implies, variable APRs can change over the life of the loan because they are tied to an interest rate, such as the Prime Rate published in the Wall Street Journal. (Wall Street Journal Prime Rate). What this means is that every time the index goes up, the APR will go up and vice versa.

Although many shy away from variable APRs, they are not necessarily negative. Remember that if the index to which it is subject falls in the future, then you will benefit. Of course, this is a double-edged sword because it could also increase.

Quick question: what factors does the bank take into account to set the interest rate?

Annual percentage rates are closely tied to the interest rate. But, to what factors is the interest rate subject? Theoretically, what determines whether your interest rate is high or attractive is the type of loan and the risk. For example, mortgages They usually have a low interest rate, since they are payable over 20 years. However, credit cards have been crowned one of the highest in terms of interest.

And what about the risk? Risk is calculated through a customer’s credit report. When the bank analyzes your credit rating, it is able to determine how good a debtor you are and, of course, it will have an idea of ​​your financial solvency status. That is why people who have an excellent credit score have access to loans and lines of credit with the lowest interest rates in the market, while other less solvent clients or with delinquent and non-payment notes in their reports, are subject to the maximum interest rate.

Can I compare the APR of a credit card with that of a mortgage?

In essence, no. Normally, APRs are compared between a credit of the same class. Now, you can use the APR to determine which financial solution is best for you when paying a debt. For example, imagine that you want to buy a new computer for $3,500 and you don’t know whether to take out a personal loan to purchase it or pay for it through your credit card. In this case, you could compare the APRs of both to get an idea of ​​which payment method would be less expensive for you.

However, the best thing to do in this case would be apply for a credit card with a 0% introductory APR. In this way, you can take your computer without paying interest for a certain period.

In conclusion

The APR is a financial factor that It will allow you to discover how expensive a credit or bank loan could be. Essentially, it is very useful, since with it you can compare between different loans and payment methods. Using this information in your favor will allow you to have greater control over the debt, especially since you will know in advance what will be the total amount that you will have to pay to the bank at the end of the contract.

Although variable APRs are tempting, it is best to opt for a fixed one (which is much more precise) and, if possible, in a bank that informs you with total transparency what fees and commissions are associated with it.

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