It’s important to know what the annual percentage rate is, how it affects certain things, and also what it affects so that you can be prepared for price increases.
Below, we’ll explain what an annual percentage rate is as well as how it’s determined. Other key factors surrounding APRs will be discussed.
What is an annual percentage rate?
To know what an annual percentage rate affects and how it is determined you must first know what it is. An annual percentage rate, abbreviated to APR, is a term used to refer to the annual rate of interest that is charged to all borrowers as well as the rate paid to investors.
This amount is shown as a percentage that represents the yearly cost of credit over the terms of all loans or, income on investments. This amount includes additional costs and fees that are charged. The annual percentage rate is used as a 'bottom line number' for comparing rates between lenders.
How do APRs work?
The value is expressed as an interest rate that calculates the percentage of principal that you will need to pay each year. It takes your monthly payments into account as well as other expenses. This value is the yearly rate of interest that is paid on investments. This does not include the compounding of the interest, only simple interest.
Laws have mandated that the APR must be disclosed to customers, especially when applying for a credit card. There’s always a strong sense of transparency within companies when working with money or anything finance-related and, this is best to gain the trust of the consumers and the community as a whole. This builds relationships, loyalty to a brand, and consumer-based publicity.
Annual percentage rate VS annual percentage yield
What is the annual percentage yield and what is the difference between the two? Well while the annual percentage rate deals with simple interest, the annual percentage yield is all about compound interest. This means that a loan for annual percentage yield will be much higher than the loan of the annual percentage rate.
These values can be used to represent the same kind of interest rate, therefore, lenders and banks will always make you aware of the more flattering number so, be aware of the difference. They should both be made clear to you by banks when doing any sort of dealings with them, by law.
How to calculate the annual percentage rate?
This is not the most important step in the process of understanding as, if you wanted to know what the annual percentage rate, is you would just look it up. But if you were ever curious enough to wonder how they calculate it, then here is your answer.
- Firstly, you must calculate the monthly payment of your loan. This includes your interest rate divided by 12 (because there are 12 months in a year and this is an annual calculation). Multiply this value by 360 as this is the number of periods. Then multiply that value by whatever the present value of the loan is.
- Secondly, use your 360 periods and subtract your payment from it. Afterwards, multiply your net present value of the loan to give you a new value. This value will be multiplied by the rate and that final answer is your annual percentage rate.
Types of annual percentage rates
There is more than one kind of APR and, you should understand how they all work and what all of them are. There is nothing wrong with bettering your knowledge of the kinds of APRs. Below are a few kinds of annual percentages rates to look at.
- Purchase annual percentage rate - this rate only applies to credit card purchases.
- Cash advance annual percentage rate - borrowing from credit cards will have a higher interest and there’re no grace periods.
- Penalty annual percentage rate - this is the highest annual percentage rate. It is also sometimes applied to balances when the terms of credit cards have been violated, such as not paying on time.
- Introductory annual percentage rate - this includes a lower annual percentage rate for a limited period. This only applies to specific transactions.
How does the APR affect your mortgage?
It would be a given to say that the APR has some effect on things such as other interest rates, exchange rates, and mortgages. But it’s always good to understand how it affects your mortgage rate so that we can identify the change before it even happens.
Now, how a mortgage is affected by the annual percentage rate is not the easiest to explain. The difference in cost will only prove true over long-term investments. A mortgage in the short-term will be of lower value if we take the annual percentage rate into account but, the moment you allow 30 years to pass, there will be a substantial difference of $10 000 with a positive win for APRs.
To conclude, annual percentage rates play an essential role in the economy whether, we’re aware of them or not. They are there and they affect things that we make use of every single day such as our mortgages.
An annual percentage rate seems to do more justice than an annual percentage yield and, it’s important to know which one you’re agreeing to when you’re looking at credit card deals or, when you take out a mortgage. Always read the fine print and be cautious of what you’re agreeing to.