The process to choose the right loan does not mean choosing the lender that advertises to offer the personal loan at the lowest interest rate. Advertised or representative interest rate fails to show the actual cost of borrowing to the borrower. In fact, it is only the nominal interest rate and does not include other costs of the loan. Due to this reason, the final cost of a loan comes out to be much higher than the advertised interest rates. Following the advertised interest rates will directly affect your finances over a longer tenure.
Therefore, knowing about annualised percentage rate (APR) and following the computation process in detail will help you to know the actual cost of borrowing beforehand.
Let us understand APR in detail and learn about how is it calculated.
What is the Annual Percentage Rate (APR)?
APR stands for Annual Percentage Rate (APR) and reflects the true yearly cost of borrowing. The APR full form in finance includes interest along with fees like processing charges and insurance, providing a clear picture of the APR loan cost for better borrower awareness.
Types of APRs
Understanding the different types of APRs (Annual Percentage Rates) can greatly influence your financial decisions. There are primarily two types: fixed APR and variable APR. A fixed APR remains constant throughout the loan term, ensuring predictable monthly payments and making budgeting easier. This stability can be particularly advantageous for long-term loans, like mortgages, where borrowers prefer consistency.
On the other hand, a variable APR fluctuates based on market conditions, meaning your interest rate and monthly payments can change over time. While variable APRs might start lower than fixed rates, they carry the risk of increasing, potentially leading to higher costs in the future.
Overall, knowing the types of APRs and how they impact your borrowing can help you choose the right loan for your needs. Whether you opt for fixed or variable rates, understanding APRs ensures you make informed financial decisions and manage your budget effectively.
How does APR work and how to calculate it?
The Annual Percentage Rate (APR) is a crucial metric that represents the yearly cost of borrowing or the yearly return on an investment, expressed as a percentage. It includes not just the interest rate but also any associated fees or additional costs, making it a more comprehensive measure of the true cost of a loan.
Formula to calculate annual percentage rate
To calculate the APR, you can use the annual percentage rate formula:
APR=(Total Interest and FeesLoan Amount)×365Loan Term in Days×100
For example, if you borrow Rs.1,000 and pay Rs100 in interest and fees over a year, the APR would be calculated as follows:
APR=(1001000)×100=10%
Understanding the effective annual percentage rate (EAR) is also important, as it takes into account the effects of compounding during the year. An annual percentage rate example could illustrate how different APRs affect overall repayment amounts on loans, helping borrowers make informed decisions based on their financial situations.
APR= [{(fees + interest)/ principal}/ n]*365*100
Here, ‘n’ is the tenure of the loan in days.
APR vs. Annual Percentage Yield (APY)
When comparing financial products, it’s essential to understand the distinction between APR (Annual Percentage Rate) and APY (Annual Percentage Yield). Both metrics are expressed as percentages but serve different purposes.
APR represents the cost of borrowing money, including the rate of interest and any associated fees, providing borrowers with a clear view of the total cost over a year. For instance, if you take a loan of Rs. 100,000 with an APR of 10%, your annual cost will be Rs. 10,000, excluding any additional fees.
In contrast, APY takes compounding into account and reflects the total amount of interest earned on an investment or savings account over a year. For example, if you invest Rs. 100,000 at an APY of 6%, the interest earned at the end of the year would be approximately Rs. 6,000, assuming monthly compounding.
Understanding these differences can help you make more informed financial decisions, whether you’re borrowing or investing.
APR vs. Nominal Interest Rate vs. Daily Periodic Rate
When navigating financial products, it’s important to understand the differences between APR, nominal interest rate, and daily periodic rate.
APR (Annual Percentage Rate) encompasses the total cost of borrowing, including both the interest rate and any associated fees, expressed as a percentage. For example, an APR of 12% means you’ll pay Rs. 12,000 annually on a loan of Rs. 100,000, excluding other fees.
The nominal interest rate, on the other hand, is the stated interest rate without considering compounding or additional costs. If a loan has a nominal interest rate of 10%, that’s the rate applied to your principal, but it doesn’t reflect the actual cost you’ll incur.
The daily periodic rate is derived from the nominal interest rate and is used to calculate interest on a daily basis. It’s calculated by dividing the nominal rate by 365. For instance, a nominal rate of 10% results in a daily periodic rate of approximately 0.027%.
Understanding these terms helps borrowers evaluate loans and manage their finances effectively.
Disadvantages of Annual Percentage Rate (APR):
- APR may exclude certain costs like closing fees or extra charges, giving an incomplete picture of the total loan expense.
- It does not account for compounding interest, which can increase the actual cost if interest compounds frequently.
- Comparing APRs across lenders can be difficult since different fees may or may not be included in their calculations.
- The complexity and variations in APR calculations can confuse borrowers, making it important to carefully review all loan terms and fine print.
How to Lower APR for a Personal loan
- Improve your credit score to qualify for a better APR loan rate.
- Compare multiple lenders to find the lowest APR percentage available.
- Choose a shorter loan tenure to reduce overall interest costs.
- Make a larger down payment or offer collateral to lower your APR loan rate.
- Avoid frequent loan applications to maintain a healthy credit profile.
Why is the annual percentage rate (APR) disclosed?
The Annual Percentage Rate (APR) is disclosed to provide borrowers with a clear understanding of the total cost of borrowing over a year. By including not just the interest rate but also any associated fees, APR offers a more comprehensive view of what a loan will cost, helping consumers make informed decisions.
This disclosure is crucial for transparency, enabling borrowers to compare different loan options easily. For example, two loans may have the same nominal interest rate, but differing APRs can reveal hidden costs or better overall value. Additionally, the requirement to disclose APR helps protect consumers from misleading lending practices, ensuring they are aware of the financial implications before committing to a loan. Ultimately, the disclosure of APR empowers borrowers to make choices that align with their financial goals and budgetary constraints.
What is a good APR?
A good APR varies based on the type of loan and prevailing market conditions. Generally, for personal loans, a good APR might range from 6% to 10%, while for credit cards, anything below 15% is often considered favorable. For mortgages, a good APR can be significantly lower, often between 3% and 5%, depending on creditworthiness and the overall economic climate.
It's important to note that individual financial circumstances play a crucial role in determining what constitutes a "good" APR. Factors such as credit score, income, and debt-to-income ratio can influence the rates offered to a borrower. Therefore, borrowers should shop around and compare APRs from different lenders to find the most advantageous terms. Additionally, understanding the terms of the loan and potential fees can help in assessing whether the APR is truly competitive, making it essential to read the fine print before making a decision.
Why is it important to know about APR?
APR is important as you will be repaying the borrowed sum at this rate. APR will help you to stay away from paying high EMI payments and also assists you in comparing multiple personal loan offers.
Knowing the APR beforehand could also help you in planning your monthly budget appropriately. You may check what EMI you will need to pay for your loan with a personal loan EMI calculator.
Knowing the APR will help you borrow funds wisely, compare among various personal loan offers, and decrease your cost of borrowing. When scouting for offerings in the market, this ensures a proper comparison, based on the total cost.
Bajaj Finserv Personal Loan stands out among the others as it has the most competitive APR and comes with several value-added loan benefits too.
