If you are planning to avail yourself of a loan, it is essential to understand the concept of APR or Annual Percentage Rate. By understanding APR, you can plan your finances well in advance and pay off the loan with ease.
The Annual Percentage Rate (APR) is the yearly interest accumulated on the funds you borrow. In simple terms, whenever you avail of a loan, you must pay a cost for borrowing funds in the form of interest. The APR represents the percentage of the total interest you will pay over the loan, as it also includes all fees and charges associated with it.
APR is an important concept because it helps you understand the total cost of funds for the entire duration of your loan. By comparing APRs across different loans, you can gain a clear idea of the actual cost of borrowing and make an informed financial decision.
Understanding the distinction between Annual Percentage Rate (APR) and Annual Percentage Yield (APY) is important for making informed financial decisions, as they represent different aspects of interest calculations. The table given below shows the key differences between APR and APY:
| Aspect | Annual Percentage Rate (APR) | Annual Percentage Yield (APY) |
|---|---|---|
| Purpose | Represents the cost of borrowing (loans, credit cards) | Represents the earnings on savings or investments |
| Compounding | Does not include compounding interest | Includes compounding interest, making it a more accurate measure of returns |
| Application | Used for loans, credit cards, and other borrowings | Used for savings accounts, fixed deposits, and investments |
| Impact for Consumers | A lower APR is beneficial as it reduces borrowing costs | A higher APY is preferable as it increases investment or savings returns |
When evaluating loans or credit products, it is essential to understand how interest is calculated and applied. Three key terms often used in lending—Annual Percentage Rate (APR), Nominal Interest Rate, and Daily Periodic Rate—may sound similar but serve different purposes. Here is a breakdown of their differences:
| Aspect | Annual Percentage Rate (APR) | Nominal Interest Rate | Daily Periodic Rate |
|---|---|---|---|
| Definition | The total yearly cost of borrowing, including interest and applicable fees | The stated interest rate on a loan, excluding fees and compounding effects | The interest rate is applied daily, calculated by dividing the nominal rate by the number of days in a year |
| Inclusion of Fees | Includes both the nominal interest rate and additional charge | Does not include fees, only the base interest rate | Does not include fees; focuses on daily interest accrual |
| Compounding | Does not consider compounding; reflects a simple annualised cost | May or may not account for compounding, depending on the loan terms | Often reflects daily compounding, impacting total interest paid over time |
| Calculation | Combines the nominal interest rate with fees, expressed as an annual percentage | Simply the stated annual interest rate without adjustments | Determined by dividing the nominal interest rate by 365 (or 360, depending on lender policy) |
| Purpose | Helps borrowers compare the true cost of loans across different lenders | Serves as the base rate for loan interest calculations | Determines how much interest accrues on a daily basis |
The Annual Percentage Rate (APR) is disclosed to provide borrowers with a comprehensive understanding of the total annual cost of a loan, encompassing both the nominal interest rate and associated fees. This transparency enables borrowers to accurately compare different loan offers and make informed financial decisions.
A good Annual Percentage Rate (APR) varies depending on the type of credit product and an individual's creditworthiness. For credit cards, an APR between 10% and 15% is generally considered favourable. Lenders assess your credit score to determine your APR; therefore, maintaining a high credit score can help secure a lower rate.
For loans, a good APR might range from 6% to 10%, while for mortgages, it can be significantly lower, often between 3% and 5%.
It is important to note that these ranges can fluctuate based on prevailing market conditions and individual financial profiles.
Let us understand the concept of APR further with this example. Let's assume a borrower decided to borrow Rs.25 Lakh as a loan to buy a home and this loan was extended at an interest rate of 7% p.a. for 20 years. The borrower will have to pay Rs.19,832 as EMI every month. However, the borrower must understand that the monthly payment that they make will go towards covering the principal loan amount as well as the interest due on the loan. With time, though the monthly payment will remain the same, the breakdown of the total amount going towards the principal and the interest will change. Initially, a major chunk of the total EMI will go towards covering the interest component of the loan. However, as time progresses, the interest component of the EMI will go down and the principal component will go up. The total interest paid by the borrower, in this case, is Rs.21,51,392. When we combine this total interest paid with the fees and charges applied by the lender over the loan and divide the amount received by the total loan value, we get the annual percentage rate.
The annual percentage rate is of two types: fixed and variable. In the case of fixed APR, the annual percentage rate remains fixed throughout the duration of the loan. However, in the case of variable APR, the annual percentage rate can change during the loan tenor. It should be noted that lenders have the right to change the APR as and when needed. However, they must inform the borrowers about this change in advance. Further, APR is disclosed in the loan agreement.
If you are planning to take a Home Loan, you can consider applying with Bajaj Housing Finance. We not only offer loans at low interest rates, but we also maintain transparency with respect to fees and charges. When you borrow from us, you will know the total cost of the loan and have all the information you need at your disposal to make the right decision.
*Terms and conditions apply
The Annual Percentage Rate (APR) is calculated by considering the total interest payable over the loan term, along with applicable fees and charges. It is obtained by dividing the total cost of borrowing (interest + fees) by the loan amount and then converting it into an annual percentage.
A 20% APR means that the total cost of borrowing, including interest and fees, amounts to 20% of the loan amount on an annual basis.
The annual rate typically refers to the nominal interest rate, which is the basic cost of borrowing without additional fees or charges.
The APR charge represents the total cost of borrowing a loan annually, including the interest rate and any additional fees charged by the lender. It helps borrowers understand the financial impact of availing of a loan.
APR can be fixed or variable in nature. A fixed APR remains constant throughout the loan tenor, whereas a variable APR fluctuates based on market conditions.
