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Annual Percentage Rate Defined
It is an expression of the effective interest rate that will be paid on a loan. It is different from the "note rate" (the advertised interest rate) because it includes one-time fees in an attempt to calculate a "total cost" of borrowing money.
In a simplified example, if you borrow $100 for one year at 5% simple interest (meaning that you will owe $105 at the end of the year) and you pay the lender a $5 origination fee, your total cost to borrow the money will be $10 ($5 for the simple interest plus $5 for the origination fee) and your APR annula percnetage rate is a bit less than 10%.
APR is intended to make it easier to compare lenders. In the US, lenders are required to disclose the APR annaul precentage before the loan (or credit application) is finalized.
While there are several acceptable ways to calculate the exact APR, the general process is:
• Total the included one-time costs and add them to the face amount on the loan
• Calculate a monthly payment for that amount at the loan's "note rate"
• Calculate what interest rate would have to be applied to just the face amount of the loan in order to equal the calculated monthly payment in step 2.
APR anual percntage rate cannot represent the total cost of borrowing.
Some classes of fees are deliberately not included in the calculation. Because these fees are not included, some consumer advocates claim that the APR does not represent the total cost of borrowing.
Excluded fees may include:
• routine one-time fees which are paid to someone other than the lender (such as a real estate attorney's fee)
• penalties such as late fees or service reinstatement fees without regard for the size of the penalty or the likelihood that it will be imposed.
Lenders argue that the real estate attorney's fee is an example of a pass-through cost, not a cost of the lending. In effect, they are arguing that the attorney's fee is a separate transaction and not a cost of lending. This is true if the attorneys fees are the same everywhere, or if the customer is free to select which attorney is used. If the lender insists on using a specific attorney however, then the cost should be looked at as a component of the total cost of doing business with that lender. This area is made more complicated due to the practice of the lender receiving money from the attorney and other agents to be the one used by the lender. Because of this, the government has made all lenders produce an affiliated business disclosure form, which shows the amount paid by the lender to things like appraisal firms and attorneys.
Lenders argue that including late fees and other conditional charges would require them to make assumptions about the consumer's behavior assumptions which would bias the resulting calculation and create more confusion than clarity.
See:
nominal interest rate
Effective annual rate
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• Annual percentage rate
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This article is licensed under the GNU
Free Documentation License. It uses material from the
Wikipedia
article "Annual Percentage Rate".
Also see:
• Having
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