When taking out a personal loan or another financial product, you will often see the annual percentage rate (APR) quoted. The APR differs from the interest rate, and this can often prove a source of confusion for the borrower. We’ve provided an example of a confusing scenario below, though we’ve used our own personal loan calculator for the numbers if you’d like to try it for yourself.
- You want to borrow $5,000 over three years, and the interest rate is 16.95%.
- On this basis, you would calculate the amount to repay is $5,847.50.
- However, the total amount to repay is actually $7,105.80 based on weekly repayments.
The reason the total to repay doesn’t equal the loan amount plus the interest rate is because this is calculated using the annual percentage rate.
“APR comes into play as the overall interest paid on your loan is calculated using a sliding scale. The total figure is then used to calculate what your repayments will be over a fixed loan term, if you are taking out a personal loan.”
Explaining and Understanding APR
To be able to differentiate between the interest rate and the APR, and why what you repay isn’t what you might expect, try to view the interest rate as the fee for the loan – the charge or the cost of borrowing. You may see some lenders calling it the base rate, or the effective interest rate. When applying for any form of credit you should always be shown or told the interest rate and the APR.
APR comes into play as the overall interest paid on your loan is calculated using a sliding scale. The total figure is then used to calculate what your repayments will be over a fixed loan term, if you are taking out a personal loan.
The example below demonstrates how the APR and total amount to repay is calculated. Note we have used a lower amount and example interest rate for this one so it is easier to understand.
- You want to borrow $1,000 over three years, and the interest rate is 5%.
- In year one, interest will be $1,000 x 5%, equalling $1,050.
- In year two, interest will be $1,050 x 5%, equalling $1,102.50
- In year three, interest will be $1,102.50 x5%, equalling $1,157.63
Therefore, your total to repay over the three years based purely on the APR is $1,157.63.
What Happens if the Sums Don’t Add Up?
If you’re borrowing on the terms above, you do the calculation yourself, but are quoted a total to repay of $1,250, for example, you’re probably still going to be lost in a fog of confusion. If the total to repay doesn’t equal what you have calculated based on the interest rate provided, fees have likely been included in the APR calculation. This isn’t an indication of your lender doing anything underhand, as including such fees is standard practice to enable then to provide you with one simple quote and a regular repayment figure. It is always worth asking what extra fees and costs are included in the APR and total to repay figure. Once you have this information, you can compare the APR as well as the additional costs with other lenders and decide on the product you wish to apply for.
“If the total to repay doesn’t equal what you have calculated based on the interest rate provided, fees have likely been included in the APR calculation.”
What Might the Additional Fees Include?
The fees included in your APR calculation may come from a number of sources. Any prepaid interest, closing fees, and insurance are typically included, although individual lenders may have their own fees or specific variables included in the APR.
Before applying for a personal loan or any other type of credit, you should take the time to understand the terminology used around interest rates, but also to speak to your lender to ascertain everything that is included in the APR, and that there are unlikely to be any additional fees or costs to be paid.
Disclaimer: This article contains general comments and recommendations only. This article has been prepared without taking account of your objectives, financial situation or needs. Before taking any action, you should consider the appropriateness of the comments made in the article, having regard to your objectives, financial situation and needs. If this article relates to the acquisition, or possible acquisition, of a particular credit product you should obtain and consider the relevant disclosure documents before applying for the product.