Advantages and Drawbacks of Annual Percentage Rates

The Annual Percentage Rate, or APR for short, is a tool used to compare the cost of loans. Costs like interest rates, transaction fees, late penalties, and other costs, vary by loan. What APR allows you to do to is to have a standardized value to compare the rates of competing lenders1. This article will detail how to use APR to your advantage. It is not a perfect standard, and admittedly has limitations; however this tool has some value and may be helpful when choosing a lender.

The Advantages in using APR

It is very easy to get confused when choosing a potential lender. Many different rates are advertized or quoted that may make a loan seem less expensive than it really is. This, in turn, makes it very difficult to compare loans on the same level. Thankfully, the law requires all lenders to list the annual percentage rate for each loan. This piece of legislation is appropriately named the Truth in Lending Act. Under this law, passed in 1968, lenders are required to quote APR and other clear “key terms” and costs involved in the lending process2.

How to Calculate APR on a Loan

To give you an idea of how APR works, please refer to the following scenario. Let’s say you plan to borrow approximately $200,000 dollars. The lender informs you that the interest rate for this loan is 7.5% and the term of the loan will be 360 months. Additionally, the closing costs amount to approximately $1000. The APR for this scenario is 7.5510%. The value was calculated using an APR calculator.

Since there are many ways to calculate the APR, some more complex than others, I recommend using a free online APR calculator, as I did in this example to double check if the lenders’ math is correct. If your calculated rate differs from the lender APR ask why, to see which costs were included in their calculation.

The Drawbacks of APR

The annual percentage rate, like most things, is not perfect. There are limitations associated with the annual percentage rate. The Annual Percentage is most effective, if all other costs associated with the competing loans are equal. This isn’t always the case. The Annual Percentage Rate, doesn’t always factor in all costs associated with the loan. Additional costs associated with the loan may or may not be included in the quoted APR3. To be safe, you need to look at more than just the APR. Instead it is important to evaluate each charge and expense related to each loan in question, to determine the best loan for you.3


Sources:
1 http://www.investopedia.com/terms/a/apr.asp
2 http://en.wikipedia.org/wiki/Truth_in_Lending_Act
3 http://banking.about.com/od/loans/a/calculateapr.htm

Sybria White

Sybria White

Sybria White is a senior at the University of North Carolina at Chapel Hill. Upon graduation in May 2010, she will leave Carolina with a Bachelor’s Degree in Sociology, a Certificate in Career Development and will be awarded a Public Service Scholar. She plans to attend graduate school to pursue a Master’s Degree in Public Health following taking a year off to contribute to a National Service Program, such as AmeriCorps. Her undergraduate career has taught her the value of a sociological perspective, which has influenced her dedication to public service. She is a volunteer for W.D. Hill Recreation center, Peer mentor for minority students and has served as an active member of several campus organizations such as Sociology club, North Carolina Health Careers and Access Program, Community Government, and Minority Advising just to name a few.

Apart from contributing public service and active involvement on campus, Sybria is very passionate about creative writing and writing in general and hopes to bring a sociological point of view to her articles. Her interests outside of writing and public service include reading books concerning fashion and spending time with her family.

A well rounded curriculum involving Business and English academics in addition to sociology, have helped shaped this young writers’ unique voice. She is eager to share her newly acquired skills and looks forward to helping others approach every day problems from a new, and perhaps, sociological outlook.
Sybria White

Latest posts by Sybria White (see all)