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[A560]Annual Percentage Rate Calculation

by Jeremy Zongker, Jer

APR for Loans:

APR is a standardized expression of the interest rate that applies to a loan or credit card, taking into account at least some of the one-time fees that are applied by the lender. There are several ways to calculate APR, but the process generally includes 3 main steps. Firstly, all one-time costs are added onto the loan amount. Next, the monthly repayment for the loan is calculated based on the loan's specified interest rate. Finally, the interest rate, that would have to be applied to the full loan amount in order for its repayments to equal the calculated monthly repayment, is calculated.

To see this in action, consider the following simplified example where you borrow $1,000 and there is a loan setup fee of $50, making the total amount borrowed $1m050. If the interest rate is 10% (compounding monthly) and the term of the loan is 12 months, then you will need monthly repayments of $92.32 to pay off the $1,050. However, a for the monthly payment of a 12 month, $1,000 loan to be $92.32 would require an interest rate of 19.32%. So, the APR is 19,32%. If the term of the loan was longer, for example the loan was for 10 years instead of 12 months, then the loan fees would be spread across this period, and the APR would drop significantly.

The aim of using APR is to calculate a total cost of borrowing, and to make the interest understandable to an average consumer, so that they can compare loans to determine the best deal and also understand the loans that they already have.

Unfortunately, despite repeated attempts by regulators to establish a single standard for the calculation of APR, it does not always represent the total cost of borrowing nor does it really create a standard that allows consumers to precisely compare the costs of a loan.

The main issues in the calculation of APR arise because the definition for the calculation of APR does not specify which one-time fees must be included and which can be excluded. For example, should APR take into account fees and commissions that are paid to someone other than the lender ? Should APR include penalties, such as late fees ? As a result, it is partly up to the lender to determine which fees are included (or not) in the calculation of APR.

In addition, APR is also highly dependent on the term of the loan. For example, the APR for a loan with a 25 year duration cannot easily be compared to the APR for another loan with a 15 year duration.

APR for Credit Cards:

For credit cards the APR is a much simpler calculation. Due to the fact that the amount of money borrowed really isn't known, you can not use the formula that is used for most loans. It's simply a calculation of what the effective interest rate is for one year when you take into account that the interest is compounded monthly.

The formula for this is apr=(interest/12 + 1)^12. So for a card with a 10% interest rate it would be apr=(0.1%/12)^12, which is apr=1.0083^12, so apr=1.104 or approximated 11%. Really you should never have to calculate this yourself though.

When calculating the true cost of your credit card, the most important factor to consider is the Annual Percentage Rate (APR). This is the amount of interest added to your card's balance expressed as a yearly rate. To determine your monthly interest rate, the APR is divided into a periodic rate, usually daily.

To determine the daily interest rate, you simply need to divide the annual rate by 365. For example:

13.49% / 365 = .0369589%

The interest rate of a credit card can be either variable or fixed. A variable rate is linked to an economic indicator such as the prime rate and fluctuates as this indicator fluctuates. A fixed rate does not fluctuate with the economy, but rather is determined by the credit card issuer. However, don't let the name mislead you. The rate is not necessarily fixed. The card issuer can increase the rate at any time as long as they give you advance notice.

If you miss a payment or are late with a payment, you interest rate can also increase. The credit card companies often use this as a reason to increase your rate to very high levels.

Methods of Computing Balances

There are several different methods for calculating your credit card balance. Whichever method your company uses must be clearly stated on your statement and in your cardholder agreement. Most major credit card companies use one of the following three methods:

1. Average Daily Balance. With this method, the issuer simply averages your daily balance by adding up the balance from each day and then dividing that number by the number of days in the billing period. Credits to your account from the month are deducted, but purchases are usually not included. This is the most common method used.

2. Adjusted Balance. This is the most consumer-friendly method used. The issuer takes the oustanding balance from the beginning of the billing cycle and deducts any payments or credits. For example, if you beginning balance was $1,500 and you made a payment of $500, interest would only be charged on the remaining $1,000. Purchases are always excluded when using this method.

3. Two-cycle Balance. This method works similarly to the Average Daily Balance method but is uses the prior two billing cycles rather than just the most recent. This is the least advantageous calculation method for card holders.

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Both Jeremy Zongker & Peter Kenny are contributors for EditorialToday. The above articles have been edited for relevancy and timeliness. All write-ups, reviews, tips and guides published by EditorialToday.com and its partners or affiliates are for informational purposes only. They should not be used for any legal or any other type of advice. We do not endorse any author, contributor, writer or article posted by our team.

Jeremy Zongker has sinced written about articles on various topics from Credit Cards, Finances and Credit Cards. Provided by Creditor Web. Creditor Web empowers consumers to compare and online.. Jeremy Zongker's top article generates over 18100 views. to your Favourites.

Peter Kenny has sinced written about articles on various topics from Credit Cards, Finances and Best Money Market. Peter Kenny is a writer for Finance 123. Please visit us at and. Peter Kenny's top article generates over 368000 views. to your Favourites.