In this post, we are going to discuss how to calculate APR (Annual Percentage Rate). APR should be a familiar term for anyone who has required finance when purchasing goods.
In some countries, lending institutions are forced to indicate the APR and not just the base rate of interest.
In taking out any form of financing it is very important to know the APR as it presents a complete picture of the financing. Without it, you could end up underestimating your future obligations
So What Is APR?
APR(Annualised Percentage Rate) is meant to show the total cost of any finance deal. It is different from the annual rate of interest in that besides the annual interest rate of interest it also includes any extra charges. The extra charges and the annual interest rate are spread over the term of the financing arrangement.
Some of these extra charges could be administration fees, exit fees, payment protection, etc.
You should note that these charges are the compulsory charges only and do not include other discretionary charges.
APR, therefore, has the advantage of giving you a complete picture of your obligations as opposed to just the annual rate of interest. Therefore if you are entering into any financing arrangement you need to ask for the APR.
What is the formula for calculating APR?
Below is the formula that is used in calculating APR.
Below is the description of the terms used in the APR formula above.
Fees: This is all the compulsory charges the lending institution will charge for the loan. It can include charges such as administration charges, payment protection insurance, legal fees, etc. Charges that may be excluded are late payment penalties
Interest: This is the total interest for the whole period of the loan.
Principal: This the loan amount
n: This represents the number of days for the loan. That means if you have taken out a 10-year loan then you need to multiply this with 365 days to determine the “n” in the formula above.
How is credit card APR calculated?
One of the weaknesses of APR is that it does not take into account the compounding effect of the loan.
What do I mean by the compounding effect? This is the fact that APR does include the fact that as a borrower you are paying interest on the amount you borrowed plus any accrued interest.
This, therefore, means that you end up paying more than what is indicated by the APR formula.
This is especially true of credit card debt where because of the way most people maintain their cards, the interest keeps piling up. Borrowers end up paying for interest on the borrowed amount plus the interest accruing on it.
That is why sometimes it feels like your payment is not making any dent on your credit card debt. If you are okay financially I would urge you to sparingly use your credit card and make sure that you pay it off before any charges.
To avoid this I would advise that one avoids paying only the minimum amount as that will mean that you are accumulating charges through interest on the accrued interest.
For those that are struggling financially, I would urge them to make sure that they formulate a plan to clear their credit card debt as soon as possible. Actually I would encourage them to “scout” for cheaper forms of credit such as getting a loan from the bank.
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When considering the APR for credit cards one needs to remember that while it includes interest costs, it does not include fees such as annual fees. So payments that seem manageable by just looking at APR may prove otherwise if you factor in other charges not included in the APR calculation.
Americans owe nearly $1 trillion dollars in credit card debt and the number of Americans struggling to pay is increasing. It is therefore advisable that we all try to run away from this burden.