What is APR, and How is APR Calculated?

The annual percentage rate, or APR, makes it easier for consumers to compare the costs of different credit products, such as home loans, personal loans, mortgages, etc. By law, the APR must be disclosed to consumers before they enter a loan agreement with the lender.

What is APR?

An APR is a comprehensive measure of the cost of borrowing money from a financial institution. It’s not just the interest rate; it also considers any additional fees or charges that may apply. Hence, it is a “true” reflection of the cost of borrowing money.

With this rate, you can compare the total cost of loans with different interest rates and fees. For example, a loan with an annual percentage rate of 10% would have a higher total cost than one with an APR of 5%, even if the interest rate is lower.

What Is Included in the APR?

There are a few things to remember when considering the annual percentage rate on a loan. First, it’s essential to understand that the APR is not the same as your interest rate. The interest rate is the cost of borrowing money, while the APR includes the interest rate plus other fees and costs associated with taking out the loan. These can include:

Application Fees

The lender charges these to cover the cost of processing your loan application.

Origination Fees

These charges help the lender cover the cost of originating the loan.

Private Mortgage Insurance (PMI)

This type of insurance is required for some home loans with a down payment of less than 20%.

Prepayment Penalties

Some lenders may even charge a fee if the borrower pays off the loan early.

How is the annual percentage rate calculated?

With an accurate calculation of the annual percentage rate, you will get a complete idea of the accumulated interest rate and other charges applicable to your loan for an entire year. To calculate this amount, you can follow the formula given below:

APR= [{(Fees + Interest)/ Principal}/ n]x365x100

Here, interest refers to the total interest amount paid throughout the loan term, and the principal is the loan amount. Similarly, ‘n’ is the days included in the loan term.

Let’s understand this with an example now.

Arun needs a loan amount of 10 lakhs that he can repay over five years. Now, consider the interest rate as 12% with a processing fee of 2% and an insurance cost of INR 5,000. In this case, the APR will be calculated as follows:

Processing fee= INR 20,000

Insurance = 5000

Interest cost = 600000

APR = [{(25000+600000)/1000000}/1825] 365 100 = 12.5%

So, the annual cost of the loan would be 12.5% for the stipulated tenure. Also, remember that it is 0.5% higher than the nominal rate quoted by Arun’s bank.

Though the annual percentage rate works as a standard measure to calculate the exact amount of interest charged by lenders, it may not work well when comparing short-term loans. That’s because it offers only the base number without considering the time when applying for credit card loans. Similarly, calculating this figure for a savings account may not show the complete picture of interest earned over the years.

How Can You Lower the APR on an Existing Credit?

If you have already taken a personal loan but want to reduce your repayment amount, you can try to minimise the annual percentage rate payable on it. Here are some tips to help you secure a lower APR:

Repay your loan on time.

Sometimes, a borrower’s credibility can help a bank or lender reduce their EMI. In most cases, the lending institutions determine your credibility according to your repayment records.

With efficient credit management and timely repayments, you can prove that you are a sincere and disciplined borrower who settles their bills on time. This gives you negotiating power to ask your lender to reduce the APR.

Keep Track of Your Credit Rating

The credit score or rating is a significant factor when calculating APRs. Hence, check your records before approaching a lender. If your credit score is low, your lender will not consider reducing the APR. Improving this score can give you a fair chance at the negotiation table.

Transfer your loan

For some borrowers, transferring it to another bank is also a rational way to reduce their annual interest rate. All you have to do is find a bank willing to offer a lower rate than your existing lender. A processing fee may apply to this process, but you can find a bank that does not charge anything to process balance loan transfers.

Apply for a New, Low-Interest Loan

Another option to reduce your annual percentage rate is to pay off your current loan with new, low-interest credit. In this case, you can compare the quotes from different banks and choose the lowest one. Pay off your other debts with this new loan and save a lot on the interest rate and monthly payments.

What Is a Good APR?

The APR you qualify for will depend on several factors, including your credit score, income, and debts. In general, the lower your annual percentage rate, the better. However, there is no magic number that all lenders use to determine whether a loan is good or bad.

The best way to find out what kind of APR you can expect is to shop around and compare offers from multiple lenders. This will give you a good idea of where you stand in the market and what kind of terms you can expect to receive.

Conclusion

The annual percentage rate can be helpful when comparing different offers, but it’s important to remember that the interest rate is only one factor in choosing a loan. Before deciding, you must consider the loan amount, repayment terms, and your financial situation.

Hence, it is better to seek help from a financial expert instead of making rash decisions on your own. Contact the personal loan or home loan experts at Piramal Finance to learn about your loan’s APR and choose a credit option with the lowest rate.