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What is Annual Percentage Rate (APR): Understanding How APR Is Calculated

  • Highlights:

  • APR is the rate that indicates the total cost of a loan

  • APR accounts for the interest rate and associated charges

  • APR helps you compare loan offers effectively

  • A lower APR indicates that the loan is more cost-effective

When it comes to unsecured financial instruments like the personal loan, common advice usually revolves around principles for borrowing cost-effectively. Tips include suggestions like, ‘check for the lowest fees’, ‘opt for the lowest annual interest rate (AIR)’ or ‘learn what is APR and calculate annual percentage rate (APR) beforehand’. While these are helpful, if you are new to borrowing, you may find yourself wondering:

  • What is the annual interest rate?
  • What is the annual percentage rate?

Simply put, AIR is the yearly interest rate applicable to the loan. But if AIR is the interest rate then:

  • What is APR and why is it important?
  • How does APR work?
  • What is a good annual percentage rate?

These are important questions you must seek answers to when you want to borrow optimally. In fact, you should also take the time to learn how to calculate APR. To ensure you’re well equipped to borrow optimally, here’s all you need to know about the annual percentage rate definition, how to calculate annual percentage rate and how it works.

Additional Reads: Calculate Personal Loan EMI

What Does Annual Percentage Rate Mean?

APR is a percentage that indicates the total annual cost of the loan by considering the annual interest rate on offer and other miscellaneous charges.

What does APR stand for? The APR meaning in banking is Annual Percentage Rate. APR includes any fees your lender may levy, such as processing charges, administrative fees, insurance costs, and others. As compared to AIR, it gives you a more accurate figure of the total yearly cost of a loan.

It is important to note that there are 2 types of APR: representative and personal. Representative APR is based on the advertised annual interest rate on the loan. Personal APR is based on the annual interest rate offered to you by the lender based on your eligibility and financial profile. It is important to note that the personal APR may be higher than the representative APR, meaning that what you get depends on your financial credentials.

Additional Read: 4 Ways to get the best personal loan interest rate

How Does APR Work and How to Calculate APR?

The APR of a loan is the annual cost of the loan expressed as a percentage. It includes the interest rate and other miscellaneous costs of availing the loan. This gives you the true cost of borrowing per year, and is especially important since lenders may lure you with a low AIR but levy hefty additional charges. For this reason, it is important to calculate the APR before you borrow so that you’re aware of the actual interest outgo with any given instrument.

To help with that, here’s the formula to calculate annual percentage rate.

APR= [{(Fees + Interest)/ Principal}/ n]*365*100

Here, ‘n’ is the tenor of the loan in days.

Why do You Need to Know the Annual Percentage Rate?

Given that the APR clearly highlights the true cost of a loan, its primary purpose is to help you compare various loan offerings better. However, it is important to note that APR doesn’t account for compounding and isn’t effective with floating interest rate loans.

That’s said, knowing the APR helps you compare loans for more than just their total cost. If the APR on a loan with better benefits is slightly higher, you are in a better position to weigh the price of these benefits than you would be if you simply judged based on the advertised annual interest rate.

What is a Good Annual Percentage Rate?

Ideally, you’re looking for an offering with a good balance between a low APR and loan features. What is a good APR would vary for different individuals and to find it, you will have to calculate the representative APR for several viable offerings. This way, you can easily identify the average and pick instruments that lie below it.

When it comes down to it, knowing the difference between the annual interest rate and the APR is what’ll help you borrow wisely. This is why knowing how to calculate APR is an important skill to have as it helps account for the total cost. When scouting for offerings in the market, this ensures a proper comparison, based on the total cost alone. This is where you’ll find options like the Bajaj Finserv Personal Loan stand out amongst the others as it has an affordable APR and comes with several value-added loan perks too!

Here, you can get approved for a personal loan up to Rs.25 lakh offered at an attractive interest rate and nominal fees. You can opt for a flexible tenor that ranges up to 60 months to keep repayment comfortable. Other benefits include quick loan processing, same-day disbursal, a minimal requirement for documentation, and digital provisions for loan management. To get funding in a completely hassle-free manner, check your pre-approved offer!

DISCLAIMER:
The content of this document is meant merely for information purposes. The personal loan features mentioned in this article are subject to updation, completion, revision, verification and the same may change materially based on policy revisions. For more details, please visit our Personal Loan terms and conditions page here.

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