What Is An Annual Percentage Rate?

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People borrow money from a bank, finance company, or another lender when they need money but don’t have enough. It can be to fix a medical problem, pay for education expenses, start a business, or vacation. The loan can be repaid with interest or the borrower may choose to take out another loan. Interest is the cost of using the money someone else has invested in an investment that will generate more income later on. 

Terms You Should Be Aware Of Before Taking A Loan

  1. APR (Annual Percentage Rate) – The interest rate that applies to the loan, which is compounded every period. For example; if you borrow $100 for two years at a rate of 10%, your monthly payment will be $9.23 for two years until you’ve paid off the total amount of $110.69.
  2. Compound Interest – Interest is calculated on the original amount and then added to that amount for each period until the loan is paid off. For example; if you borrow $100 at a rate of 10% for two years and then $10 at 12% for one year, your total interest charged for two years will be $111.71.
  3. Simple Interest – In simple interest, the interest remains the same until the loan is paid off. For example, if you borrow $100 and the rate is 10% for one year and at a later time, $10 at 12%, your interest on that first loan (total interest charged) will be $11.19. The same amount of money is borrowed but the total interest paid each period will increase as time goes on.

Annual Percentage Rate (APR) in Detail

APR is a key factor in deciding whether to take out a loan. As the APR increases, the cost of taking out a loan increases too. It’s important to know that using a credit card has an average annual interest rate of around 20%. If you borrow $100 for one month at 20%, then pay it back over one year, your APR will be 520% (520% of $100).

How Annual Percentage Rate (APR) Works?

The Annual Percentage Rate (APR) is a measure of the cost of credit. It is defined by the following formula:

Annual percentage rate = (((fees+interest rate)/principal)/n)*365)*100, where:

Interest=Total interest paid over the life of the loan

Principal=Loan amount

n=Number of days in the loan term

​Types of APRs

  1. Fixed APR – When the Annual Percentage Rate remains fixed over the life of a loan. For example, Jim’s car rental contract specifies a fixed APR of 20%. This means that he will pay $1 for fees and interest per day for each dollar he borrows over the life of the contract. It’s also called a “flat rate”.
  2. Variable APR – This is a type of adjustable-rate which may change periodically on an agreed-upon schedule. For example, a variable APR may change with the prime rate. This type of rate is used in some credit cards.

APR vs. Annual Percentage Yield (APY)

APR is the percentage rate that applies to a loan, but APY is the yield that suggests how much money will be earned by holding a certain type of loan. Therefore, APR and APY are both significant factors in deciding if it’s worth borrowing money and how much one should borrow. Most loan rates quoted to consumers are APR rates because they are used to determine the costs of loans as well as to determine eligibility for loans. However, APR doesn’t take into account the effects of compounding interest, which APY does take into account.

Disadvantages of APR

Generally, the advantages of APR are that it is easy to understand and APY is just a calculation based on the size of the amount borrowed over a certain period. However, APR does have its disadvantages as well:

  1. It has no way of taking into account any increases in interest rates. If inflation wins, then APR will make you poorer than your timing implies, since an increase in the price of goods means that your total interest payments will increase by greater amounts than just an increase in a fixed rate.
  2. APY takes into account the interest paid by the borrower, but for fixed-rate loans even if you pay the minimum payment each period you may still make a large number of interest payments in the long run. The reason for this is that a fixed-rate loan has a lower APY than an adjustable-rate loan, which gives you an advantage when your rates rise.
  3. Fixed-rate loans tend to have much higher payment amounts relative to their APR than variable rate loans. 

Endnote

If you are looking to borrow money using a loan with a low annual percentage rate, you should get the loan from a reliable institution such as Same Day Cash Loan. Don’t feel stressed, there are several lending institutions that help people by providing instant cash in emergencies.

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