What Is Annual Percentage Rate Or APR And Its Importance In Loans
The Annual Percentage Rate or APR (sometimes referred to as nominal APR or effective APR) is the annualized interest rate. It should not be confused with the monthly interest rate levied on loans and credit cards. It can be explained as the finance charge on borrowed money expressed as an annual interest rate.
APR is easily confused with the term interest rate, which is the percentage charged on the principal amount on the borrowed money. APR on the other hand includes the whole cost of the loan including the payment schedule, fees charged etc. Or in other words it is the entire cost of borrowing.
Why is APR Used?
APRs are usually applied on credit cards and mortgage loans, however, many personal loans also use APR. It is used to compare the cost of transaction of credit cards before deciding the right one. It is a more effective rate when used to compare loans. The APR expressed as a percentage includes broker fees, discounts, rebates, etc. and hence an effective way to compare financial products.
Generally the APR will be greater than or equal to the interest rate. However, (for example) if a lender offers a rebate on the interest to the borrower then the APR will fall below the interest rate.
Annual Percentage Rate comes in as a handy metric when two lenders offer the same interest rate and monthly EMI. In such a scenario chose the one that has a lower APR as it means lower charges and fees.
It is mandatory for the lenders to mention the APR to the loan (or credit card) applicants. It helps them better estimate the total cost of borrowing. Most of the times companies advertise interest rates, but they are required to tell the customers about the APR before signing an agreement.
There are also different types of APRs (Purchase APR, Balance transfer APR, Introductory APR, etc.) that a consumer should be aware of; most of them are applied on credit card.
Companies also promote a 0% APR (temporary promotional offer) on its credit cards or loans. However the consumer can only avail the 0% offer for a few months. Consumer should also check for other hidden fees such as balance transfer fee which is usually 3%.
If a loan applicant chooses a loan with lower APR then the repayment will be lesser during the loan tenure. Understanding the APR will help the applicant choose a better loan or credit card based on their credit profile after informed calculations.