The annual percentage rate (APR) is a method of doing a comparative study of the costs relating to a loan. Though this method is not a foolproof one, it does give you a good benchmark to compare the costs percentage on several loans.
Loans can be baffling for a common man. Shrewd lenders may quote a variety of numbers meaning different things. In a bid to lower the ambiguity and confusion with regard to loans, the government of U.S.A had passed the Truth in Lending Act. One of the requirements stated was that lenders must quote APR to the potential borrowers.
The annual percentage rate, nominal APR as well as effective APR is the calculation of the annualized rate of interest instead of simply a monthly rate or fee which is applicable on a mortgage, loan, credit card and others. It refers to the finance charge that is expressed for an entire year. In general terms, the nominal Annual Percentage Rate is the rate of simple interest over a year. The effective Annual Percentage Rate refers to the fee and the compound rate of interest for the whole year.
Thus if you take a loan which has a 10% rate, you will be paying $10 per $100 you annually borrow. Considering all other things remain equal, you will desire for a loan having the lowest APR. Unfortunately this is not the case in real life situations and APR on a mortgage may include Private Mortgage Insurance, discount points as well as processing fees.
Nominal and Effective APR
The calculation of the nominal APR is done by multiplying the rate during a specific payment period with the number of times the payments are made over a year. The exact meaning of effective APR varies greatly in every jurisdiction and is dependent on such factors as fees for loan origination, participation fees, service charges and late fees.
The calculation relating to the effective APR, which is the fee along with rate of compound interest also varies. This is also dependent on the basis of whether the participation or origination fees are included in the whole amount or are treated as a loan amount for a short – term period to be paid off at the first instance. If the start – up fees are included in first payments, the balance amount may call for a higher interest for being held up by the additional payment periods.
APRs for credit cards
Most creditors quote low APR for the initial few months and subsequently raise the APR. Customers should carefully look into the validity of the APR before purchasing the credit card. Customers must also check out for annual fees and other hidden charges. The creditor may skillfully offer you a temptingly low APR but charge greater fees.
All said and done, it can be concluded that you ideally should not evaluate the viability of a loan based solely on an APR quote. You have to take into consideration every charge relating to your prospective loan as well as the tenure in order to get the perfect deal.