Annual percentage rate (APR)

Definition

The annual percentage rate (APR) is a standardised way of expressing the overall cost of borrowing, including both the interest rate and certain fees, as a single percentage. It’s designed to provide borrowers with a clearer understanding of the true cost of a loan or credit product.

What is the annual percentage rate?

The APR takes into account not only the interest rate charged on the borrowed amount but also any additional costs such as origination fees, points, and certain other finance charges. By including these costs, the APR gives borrowers a more accurate representation of what they’ll actually pay over the life of the loan or credit agreement.

Lenders are typically required to disclose the APR to borrowers when offering loans or credit, allowing borrowers to compare different offers more easily and make informed decisions about their borrowing options. Keep in mind that while the APR provides a helpful comparison tool, it may not cover all potential costs, so it’s important to carefully review all terms and conditions before committing to a loan or credit product.

Example of annual percentage rate

1. Car loan details:
   • Alex is in the market for a new car and decides to finance the purchase with a loan. He borrows £20,000 from a bank to be repaid over 5 years.
2. Nominal interest rate:
   • The bank offers Alex a nominal interest rate of 5% per year on the loan.
3. Additional fees:
   • In addition to the interest rate, there are some upfront fees associated with the loan, such as an origination fee and processing fees. These fees amount to £500.
4. Calculation of APR:
   • The APR is calculated by considering both the interest rate and the additional fees. In this case:
     APR = 5% + (£500 / £20,000) × 100% $=7.5\%$

   The APR, in this case, is 7.5%. It provides a more comprehensive view of the total cost of the loan, including both interest and fees.