Do you know what is APR?

When you borrow money from a bank or any other lender, you have to pay back the borrowed amount and also interest on top of that. All these payments have to be made within agreed upon time period. We can think of interest as the cost of borrowing.

Suppose you need $1,100 for one year, and your bank offers to lend you and charges 7% interest. But is that the true interest rate? Not if the bank is asking for some fees, like application fee or credit report fee etc. In that case your true interest rate will turn out to be higher than the 7% that bank offered. All lenders are required by law to inform the borrower of the “Annualized Percentage Rate,” also known as APR. APR is a better indicator of what interest rate you are paying on the loan.

In the example above, the interest payments for the year will be 7% x 1,100 = $77. However, suppose that to get the loan you had to also pay a non-refundable application fee of $100. What is your APR?

To understand APR, determine the net amount of cash you got from the bank. You got $1,100, the amount you borrowed, but paid back $100 in application fee. So the net cash you got was $1,000 (=$1,100 - $100). However, you still have to pay $77 in interest. So what is the true interest you are paying? It is 7.7%, calculated as $77 (your interest payment)/ $1,000 (the net cash). The APR for your loan will be 7.7%. Higher the fees, higher will be the APR.

In this example we assumed that the loan period was one year. If the loan period is more than one year, then APR will be less than 7.7%, but still more than 7%. So next time when you borrow money, make sure to ask for APR.