How to calculate APR
APR is calculated by taking into account the Total cost of borrowing which includes the interest rate on the loan, and any additional fees. This is then expressed as a percentage of the total amount borrowed.
APR = (Total cost of borrowing / Loan amount) x 100%
Let’s say you have a loan amount of N1,000,000 with an interest rate of 7% and an arrangement fee of 3%, here’s how to calculate the APR:
The total cost of borrowing would be the sum of the interest and the arrangement fee:
Total cost of borrowing = (loan amount x interest rate) + (loan amount x arrangement fee)
= (N1,000,000 x 0.07) + ($10,000 x 0.03)
= N70,000 + N30,000
= N100,000
APR = (Total cost of borrowing / Loan amount) x 100%
= N100,000/N1,000,000) x 100%
= 10%
Annual percentage rate vs Interest rate
The Annual Percentage Rate and Interest rate have been used interchangeably but they have distinct differences.
Interest Rate is the cost incurred when a principal amount is borrowed. It is the amount charged by a lender during the loan process as the accrued profit on the given loan. The interest rate is influenced by factors such as the state of the economy, federal regulations and the lender themselves.
Annual Percentage Rate is the total cost involved during the process of getting a loan. It is an addition of both interest rate and other costs like the commitment fee, completion fee, closing costs, etc. When considering a loan or comparing loans, the Annual Percentage Rate is usually the best factor to consider.
Annual Percentage rate is not the same as interest rate, it is a combination of interest rate plus other costs.
Fixed APR vs Variable APR
These are the two basic types of Annual Percentage Rates:
Fixed APR remains the same throughout the entire span of the loan. Regardless of what the market interest rates are, the fixed APR does not change from the initial amount it was set to be.
Variable APR fluctuates as market rates change. A reduction in the market rate reduces the interest rate being paid and vice versa. Such interest rates are found in mortgages, credit cards, personal loans, derivatives, and corporate bonds.
Key Points
- APR takes into account all of the costs associated with a loan, including fees and charges, and provides a more accurate representation of the true cost of borrowing.
- Annual Percentage rate is not the same as interest rate, it is a combination of interest rate plus other costs.
- An Annual Percentage rate can be fixed across the repayment span or it can fluctuate based on market conditions.
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