What’s APR and how to calculate it
When you are borrowing money from financial institutions whether traditional or new-age expect to be charged an annual interest rate for the borrowing services they offer. Being familiarized with the concept of APR can help you make more informed financial decisions. This blog is your handy guide to understanding what APR actually is, how it must be calculated, and how it works. We will also be taking you through the difference between fixed and variable APR.
What is APR?
When you are familiar with the concept of APR, you will be able to truly understand the cost of borrowing involved. APR is an acronym for annual percentage rate, signifying the yearly interest a lender charges on a loan. It refers to the yearly interest that is incurred by the borrower on a sum of money that the lender extends as a loan. Cumulatively it is the cost a client pays on a loan that includes both interests as well as any other applicable fees.
Typically, it is calculated over a one-year period and expressed as a percentage, representing the actual annual cost of funds over the tenure of a loan or the income that will be earned on the part of the lender. At its crux, the APR is a comprehensive collection of all borrowing costs, including charges incurred, a fee for paying late, or other administrative purposes.
How to calculate APR and how it works
The APR is always expressed as an interest rate and it determines what percentage of the principal you will be expected to pay as a borrower annually, broken up into monthly payments. You can calculate the APR you will be incurring by multiplying the periodic interest rate by the number of periods in a year in which the issuer applies. The following are the steps on how to calculate the APR:
Consider the terms of the APR formula
The terms of the APR formula constitute a principal amount, interest rate, time, and administrative costs. The principal basically means the amount of money that is being borrowed. Interest rate is the proportion of the principal amount that is charged as interest to the borrower, which is expressed as a percentage of the loan. The term time is the duration of the loan term, which is expressed as the number of days of the loan term.
Here’s the formula to calculate APR
APR = ((Interest + Fees / Principal or Loan amount) / N or Number of days in the loan term)) x 365 x 100.
Fixed APR and variable APR
In the case of a fixed APR, the interest rate remains constant throughout the term of the loan. Variable APRs on the other hand can change, depending on how the lender adjusts the same to make it more suited to market changes or if you are in a situation where you pay your loan after the agreed time period. Lenders always inform borrowers of the changes that are going to occur on the APR with reasons for the same as well. It will do you good to know that most credit cards have variable APRs, but you can also find them among private student loans, personal and home equity lines of credit, and adjustable-rate mortgages.
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