An Annual Percentage Rate (APR) is an annual interest rate used in computing interest for almost all types of loans including credit cards and mortgages.A nominal APR is just a simple interest rate for a full 12 months while the effective APR is the total fees plus the compounded interest.
In most cases, fees can include late fees, monthly service charges, origination fees, participation fees, and the likes. If only APR is stated, it means the nominal APR is used which is the interest rate multiplied by the number of times amortization is paid within a year.
In the United Kingdom, United States of America, and other countries, creditors are required to explicitly state the APR in the loan agreement.
Limitations of Annual Percentage Rate In Mortgages And Credit Cards
In mortgages, lenders decide what is included in the computation of APR. There is really no standard in what is included in the annual percentage rate. Therefore, anyone who wants to apply for a home mortgage must ask the lender what is exactly included in the APR so that he can properly compare mortgage offers from different lenders.
In most cases, closing costs and mortgage insurance aren’t included in the declaration of APR. As such, it is important for a would-be borrower not to base his decision on the APR alone.
What They Never Tell You About Compounding?
With credit cards, companies never tell their borrowers about compounding. Credit card users pay more than the Annual Percentage Rate especially when they don’t pay their monthly credit card bills in full.
Like mortgage companies, credit card companies charge other fees aside from the APR and these charges differ among creditors. Thus, those people who apply for credit cards must find out about other fees they have to pay when they avail of the card.
Effect of The Annual Percentage Rate On The Budget
A loan is beneficial to people who know how to pay it. It is possible to own a car or a house by taking a loan to pay for high ticket items. However, the loan has to be paid on time in order not to accumulate penalties.
In effect, the APR can be your friend or enemy depending on how well you pay your loan. Of course, if you’re delinquent with your loan payments, losing your house or car is a possibility.
The Annual Percentage Rate Trap
First, there are unscrupulous lenders who don’t include other fees in the APR therefore borrowers often get the surprise of their lives when they are asked to pay other fees when they sign up for the loan.
These fees make the cost of borrowing more expensive. However, there are also honest lenders who include all fees in the APR. This method will make the APR higher but borrowers won’t be surprised later on that they have to pay other fees aside from the APR.
The Rate May Not Apply To You
Second, the advertised APR may not be applicable to all borrowers. Most lenders advertise their most competitive APRs to lure potential borrowers. In general, the lowest APR is applied only to those loans taken by people with high credit rating. Those individuals with bad credit often have to pay more interest.
All About the Term Of the Loan
Third, the Annual Percentage Rate is based on the term of the loan. Paying off a loan earlier than its term will mean the borrower has to pay a higher APR than what was orginally quoted. Most loans today charge a high up-front cost.
A borrower who pays his loan in full before its term won’t be able to spread the upfront cost over the term of the loan.
Lower Payments but Longer Terms
Fourth, a lower APR allows for lower monthly payments but for a longer period of time. A loan which charges a low APR often requires a high upfront cost. This means that the borrower needs to source thousands of dollars to pay the lender at the time the loan is made.
This amount of money can be used in other more important purchases than paying off a lender. A would-be borrower must be wise enough to weigh things before signing up for a loan.
Look At More Than Just APR When Deciding
Therefore, it is important for borrowers not only to rely on the APR when evaluating a loan because it doesn’t present the whole picture. The quote from each lender must be examined carefully. It is important to find out about other fees that will be charged once the loan is taken. This way, the borrower will be able to make a wise decision on whether to take a loan or not.