What is annual percentage rate?

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Date16/07/2016

Annual percentage rate or, in other words, APR is total expenses of credit which have to be repaid by borrower and which is expressed as a percentage from the total amount of loan. Annual percentage rate describes the interest rate for a whole year, not for a month and other periods of time. Annual percentage rate refers to all credits – fast loans, mortgage loans, consumer credits, car loans, student loans, credit cards etc.

It should be mentioned that annual percentage rate includes not only interest payments, as it might seem, but also such expenses as commission fee, taxes and other payments which borrower pays from the moment when credit agreement is signed to the moment when the last credit payments are done. Annual percentage rate is formed by value of existing and further commitments which are expressed as a percentage.

Both banks and non-bank lenders calculate annual percentage rate, using special formula which is called APR formula. Formula of annual percentage rate includes such variables as the number of cash flows paid by the lender, the sequence number for the cash flows paid by the lender, the cash flow in period, the total number of cash flows paid by the borrower, the sequence number of the cash flows paid by the borrower, the cash flow of period and the interval which is expressed in years and fractions of a year between the date of the first cash flow and the date of cash flow.

Taking into account that annual percentage rate is one of the most important indicators to which potential borrower pays attention before choosing the most appropriate lender and loan, the law provides, that annual percentage rate has to be shown in such places as credit agreements and credit advertisements. It is one of those indicators which are determined by lenders individually, therefore, it is important to not to relay on one source of information, but compare them.

Talking about annual percentage rate, one nuance has to be mentioned. Annual percentage rate is used both in sector of banks lending and sector of non-bank lending, but actually it is not correct. Originally formula of annual percentage rate was created for calculating of rates of long term loans which are ensured by banks, but, as it is known, the majority of non-bank loans are short term loans. In one word, the market of lending services has changed because of appearance of non-bank lending, but formula of annual percentage rate has not changed. It is clear, that mathematically rates of long term loans and short term loans significantly differs. For example, APR of long term loans is measured in couple of tens, but APR of short term loans is measured in several hundreds. Comparing and choosing the most appropriate loan, this nuance should be kept in mind.