It is important to understand the APR before applying for a credit card or a loan.
It is important to understand the APR before applying for a credit card or a loan.

You might have seen and heard about APR when looking for a credit card or a car loan. An annual percentage rate or an APR will give you an insight into how much it will cost you to take a loan. If you know apr how to calculate, it will allow you to compare loan products and make the right decision. 

APR is the total cost of a loan. It includes all costs and fees. APR is calculated annually and applies to all credit cards as well as loan products like auto loans, student loans, and home loans. APR will be shown as a percentage and lower the APR, better it is for you. It will reduce the cost of borrowing. There are several fees in the APR which include mortgage loan origination fees, transaction fees, credit report fees, home appraisal fees, broker fees, interest, processing fees, and the fees charged from a creditor for the loan. 

APR is the real cost of borrowing and it includes all costs and fees in addition to interest.

Difference between the interest rate and APR

A lot of people get confused between the interest rate and APR. An APR includes all other fees and it shows the total cost of borrowing in a year. An interest rate does not include anything except the interest. This is why the APR will be higher than the interest rate on a loan. 

Use of APR

If you want to know the real borrowing cost, you need to calculate APR. Do not simply pick a loan that offers the lowest interest rate because it will not reflect the real cost of borrowing. When you compare two loan products based on the interest rate, you will not make the right decision. This is where APR comes into play. APR can be used to compare all types of loan products and between different lenders. You can make the right borrowing decision by comparing the APR. 

How to calculate APR

The process of APR calculation on a basic loan is very simple. You will need three details- the principal amount that you borrow, the tenure of the loan in days, and the fees, cost, and interest amount. If you want to know apr how to calculate, follow the below-mentioned steps:

  1. Add the interest charges and divide by the loan amount or the loan amount outstanding.
  2. Now multiply this figure by 365.
  3. Further, divide this number with the number of loan days outstanding.

Here is an example for better understanding. Let us assume that you have a loan of $1,000 with $150 in interest and fees. The loan tenure is 30 days.

  1. $150 ÷ $1000 = 0.15
  2. 0.15 X 365 = 54.75
  3. 54.75 ÷ 30 = 1.825% APR

Calculating APR using spreadsheets

If you find it difficult to calculate the APR manually, you can use a spreadsheet for the same. When you calculate APR on mortgage loans, it can be a bit complex. You can create your own APR spreadsheet on Microsoft Excel as explained below. 

In the first cell A1, you need to put the tenure of the loan in months.

In cell A2, you need to enter the formula PMT using actual numbers. PMT is the interest rate/months, total tenure in months, and the fees and principal amount. 

In A3, provide the total loan amount,

Now in the next cell, write 0 because you will have zero balance after repayment of the loan,

Next, in A5, use =RATE(A1,A2,A3,A4) *12,

Now right click on cell A5 and choose Format Cells. Here, select Percentage to see the APR in the form of a percentage. 

Calculation of APR on a credit card

As mentioned above, there are different ways of calculating APR for different loan products. When it comes to calculating the APR on a credit card, it will be based on the interest rate and prime rate. Both the rates set by banks change from time to time and the issuing company is not obligated to inform you about the same. Hence, keep a watch for any changes. If you want to find the APR on your credit card, you only need to add the U.S. bank prime loan rate and the rate of interest the card issuer charges you. Let us assume the U.S. prime rate is 6% and the interest rate charged by the card issuer is 4%, then the credit card rate will be 10%, a sum of both the rates applicable to you. 

The manual calculation of an APR is not easy. However, if you prepare a spreadsheet and use it every time before borrowing, it will give you the right result. Mortgage lenders are required by law to provide the APR to borrowers, hence, in a mortgage loan, you can skip the effort. Make a well informed borrowing decision by understanding the impact of APR on your monthly outflow. 

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