What is... | November 23, 2012

What is APR?

The three-letter acronym APR – or annual percentage rate – is often printed at the end of insurance or loan advertisements. Although sometimes in the fine print, APR is very important for borrowers. It is helpful partly because it allows the cost of loans to be compared against the cost of other available deals.

Credit cards, store cards, overdrafts all have different APRs. It is important to check the rate so you don’t get caught out.
The European Commission defines APR as “the total cost of the credit to the consumer expressed as an annual percentage of the total amount of credit”.

How to calculate APR
APR is calculated by taking the annual interest charged, dividing it by the total loan amount then multiplying by 100. This gives the cost of the loan as a percentage, which can be compared against other loans.
For example, a EUR100,000 mortgage charging EUR5,000 interest over a year has an APR of 5% (5,000 / 100,000 x 100).

More than meets the eye
Some governments try to make APRs as transparent as possible, taking steps such as requiring lenders to include APRs in agreements and display a ”typical” rates in ads.
Despite this, there are still traps to watch out for.
The United Kingdom’s Money Advice Service highlights big differences in APRs, giving examples of post-graduate loans at 8%, credit cards at 18% and payday loans at a massive 2165%.
Be aware if you find a “per month rate” – as this needs to be multiplied by twelve to get the annual percentage rate. So 2% per month is 24% APR.
The Better Business Bureau point outs it is important to check whether APR is “variable” or ”non-variable”. Variable APR can rise or fall on a monthly or quarterly basis.
”Teaser” rates – an introductory APR which will rise in the future – can be another pitfall and “typical” APRs advertised may not apply to everyone.
It can pay to read documents carefully to understand the terms used.

International variation
The way APR is calculated can vary between countries depending on which costs are taken into account.
In our earlier example of the EUR100,000 mortgage, the EUR5,000 cost used to determine APR only includes interest and does not take and taxes, commissions or other fees into account. To try and make APR rates comparable across all European Union member countries, the European Commission issued a directive in 2008 that states APR would include “all commitments (drawdowns, repayments and charges), future or existing, agreed by the creditor and consumer”.

What to do
When borrowing, it can pay to compare APRs between lenders. But remember that other factors – such as the level of service, loan terms and flexibility and other charges – may come into play.
Go a step further by translating the APR into the actual currency amount paid in a year. Research from Mexico suggests borrowers may make more informed decisions when presented with fees in pesos rather than percentages – perhaps combatting effects of money illusion.


eZonomics team
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