How is APR Calculated?
Annual Percentage Rates (APR) can be confusing. And, misunderstanding what financial terminology means can be costly. Lenders of all sorts, ranging from credit card to mortgage companies are legally required to disclose the annual percentage rate charged on the money they lend. Learning how APR is calculated can allow you to comparison shop for the right loan, factoring in the total cost of the loan, interest and any fees or additional costs. This information can also help you make good choices about taking on debt or repaying debt.
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Definition
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APR, or annual percentage rate, is the total interest rate charged over the course of a year on a loan, credit card or mortgage. The nominal APR is the simple interest rate on the loan for a year. The effective APR includes any fees or charges, as well as the compound interest rate. The exact definition of all of these terms can vary slightly depending upon your jurisdiction and legalities specific to your area.
Significance
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Borrowing money comes with costs. The APR tells you specifically how much your loan will cost over the duration of your loan. If your credit card has a 19% APR, you will pay $19.00 for every $100.00 borrowed per year. When choosing the right loan, look for one with a low APR, but also take into consideration any and all fees associated with getting the loan or annual fees as these will most often not be included in the quoted annual percentage rate.
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Formula
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The mathematical formula for calculating APR is quite complex. You will need the loan amount, any additional costs, the interest rate and the term of the loan in order to determine the total annual percentage rate. If you would prefer to do the math on APR yourself without the aid of an online calculator, you can do so in Microsoft Excel. The Excel formula is =Rate(nper,pmt,pv). Nper is the number of periods on the loan, pmt the loan payment amount, and pv the principle value. The answer is the rate per month, so multiply by 12 and figure to the second decimal place for the APR. Excel can also be used to convert APR calculations to annual percentage yield calculations for investments compounded monthly.
Calculators
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The easiest way to calculate APR is to use an online calculator. These calculators are designed for specific types of borrowing, so you can choose one that will work best for your needs. Keep in mind that you will need payments, total amount borrowed, and any additional costs in order to accurately figure the annual percentage rate on a loan. You can also find calculators that allow you to calculate APR or APY (annual percentage yield) on an investment.
Misconceptions
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Quoted annual percentage rates can be misleading. This is certainly true for short term loans, which typically have substantial fees on a two week to one month basis that calculate to an APR well over 300%. Loan fees and costs may or may not be added to the reported APR, and you should carefully assess all expenses associated with borrowing money. Credit cards most often report the nominal APR compounded monthly, a figure which may be less than the effective annual rate.
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