Annual Percentage Rate

It refers to interest for one year that borrowers have to pay to lenders/banks.

APR calculates what percentage of the principal you’ll have to pay each year by taking things such as monthly payment into account and without accounting for  the compounding of interest within that year. For example let say you have taken loan of 10 lakh in october 2021 and from november 2021 to oct 2022 you paid 1000 every month so in 1 year you paid 12,000 on the principal 10 lakh so your interest payment for this case would be (12000/10,00,000)*100= 1.2%. but to calculate APR we also need to take into account the other fees such as broker fee, closing costs etc. Let say other cost is 5000 so our total cost is 12,000 for interest payment+5000  for other expenses so our APR would be  (17,000/10,00,000)*100 = 1.7%. we can see that our nominal interest rate is only 1.2% whereas our APR is 1.7%, generally APR remains greater than nominal interest rate.

Why APR is better than nominal interest rate

The APR is the more effective rate to consider when comparing loans. The APR includes not only the interest expense on the loan but also all fees and other costs involved in procuring the loan. These fees can include broker fees, closing costs, rebates, and discount points. These are often expressed as a percentage. The APR should always be greater than or equal to the nominal interest rate, except in the case of a specialized deal where a lender is offering a rebate on a portion of your interest expense.

Written by - Aman Singh | LinkedIn