What is the annual percentage rate: APR Meaning, Calculation & Impact on Borrowing

The annual percentage rate (APR) is the total cost of borrowing money, including interest and fees. It helps you to compare loans and calculate funds ( how much you'll pay back).

Example:
 

Let’s understand APR with Jitendra's example.
 

• Jitendra needs ₹10,00,000 for his business and takes a loan.
   
• The bank offers a 12% APR, meaning he pays 12% extra per year on the borrowed amount.
   
• Over one year, his total interest would be ₹1,20,000 (12% of ₹10,00,000).
   
• If he repays in 5 years, his total interest will be higher because the APR applies every year.

This table helps you understand how APR affects different loans:
 

This table shows different loan amounts, APR, interest, and total payment.

This article explains how APR functions in business loans and helps you understand the merchant payments.

Meaning of APR (Annual Percentage Rate)

The real annual cost of borrowing money is the annual percentage rate, or APR. It covers interest as well as any additional fees charged by the bank.

Let's understand with Ramesh's example:
 

• Ramesh takes a ₹5,00,000 personal loan for 3 years
   
• The bank says "12% interest rate," but the APR is 14%
   
• Why the difference? Because the bank adds:
   
  • ₹5,000 processing fee
  • ₹2,000 insurance charge
  • ₹3,000 other charges
     
• These extra ₹10,000 make the actual cost higher than just 12%

How APR affects Ramesh:
 

• At 12% interest only: ₹1,80,000 total interest (₹60,000 per year)
   
• At 14% APR: ₹2,10,000 total cost (₹70,000 per year)
   
• That's ₹30,000 extra over 3 years because of fees!

This table shows how different loans with the same interest rate can have different APRs:
 

Key things to remember:
 

• APR is always equal to or higher than the interest rate.
   
• More fees = higher APR.
   
• Always ask for APR, not just interest rate.
   
• Even a 1% APR difference can cost thousands extra.

APR gives you a fair comparison of loans by presenting the whole picture. Ramesh learned that a loan with a lower interest rate but higher fees may be more expensive!

How to Calculate APR?

The entire annual cost of a loan, including interest and fees, is known as the annual percentage rate, or APR. It shows the actual cost of borrowing money as a percentage.

Example:

Nitin acquired a ₹20,00,000 home loan. The bank charges ₹20,000 in processing fees in addition to 10% annual interest. The loan has a 5-year (60-month) term.

Step-by-Step APR Calculation:
 

These pointers help you to understand how to calculate APR.
 

1. Calculate Total Interest:
   • Yearly Interest = 10% of ₹20,00,000 = ₹2,00,000
   • Total Interest for 5 Years = ₹2,00,000 × 5 = ₹10,00,000
      
2. Add Fees to Interest:
   • Total Fees = ₹20,000 (one-time)
   • Total Cost of Loan = ₹10,00,000 (interest) + ₹20,000 (fees) = ₹10,20,000
      
3. Find Yearly Cost:
   • Yearly Cost = ₹10,20,000 ÷ 5 = ₹2,04,000
      
4. Calculate APR:
   • APR = (Yearly Cost ÷ Loan Amount) × 100
   • APR = (₹2,04,000 ÷ ₹20,00,000) × 100 = 10.2%
      

Why is APR 10.2% and not just 10%?
 

The APR is slightly higher than the interest rate because the processing fee (₹20,000) increases the overall cost.

This Table Helps You Understand APR vs. Interest Rate
 

In this table, you can see which is a better interest rate and APR.

Key Takeaways:
 

• APR is higher than the interest rate if fees are added.
   
• Always check the APR to know the actual cost of a loan.
   
• Nitin’s loan has a 10% interest rate but a 10.2% APR due to fees.

Nitin and other borrowers can compare loans more fairly. Always look at the annual percentage rate (APR), not just the interest rate.

How Does APR Impact Borrowing Decisions?

The actual annual cost of a loan, including interest and fees, is known as the annual percentage rate, or APR. A low APR makes loans easier to get, but a high APR shows that borrowing is costly.

Example:
 

Akash compares loan APRs, chooses Bank B to save ₹2,25,000 over 5 years.
 

• Akash wants to buy a shop for ₹15,00,000 to expand his business.
   
• Bank A offers a loan at 14% APR, while Bank B offers 11% APR.
   
• Akash calculates the extra cost:
   
  • Bank A (14% APR): ₹2,10,000 interest per year (14% of ₹15,00,000).
  • Bank B (11% APR): ₹1,65,000 interest per year (11% of ₹15,00,000).
     
• Over 5 years, Bank A costs ₹10,50,000 in interest, while Bank B costs ₹8,25,000.
   
• Akash realises Bank A is ₹2,25,000 more expensive, so he avoids it and chooses Bank B.
   

Choosing the lower APR saves Akash a significant amount of money.

Why APR Matters in Borrowing Decisions?

A lower APR makes your loan more affordable, which is excellent for your budget!
 

• Higher APR = More money repaid = Less profit for Akash.
• Lower APR = Less burden = Easier repayments.
• If APR is too high, Akash may delay buying the shop or find other funding.

This Table Helps Compare Loan Options:
 

In this table, you see the comparison of APR with the different options.

Key Takeaways:
 

• A small difference in APR can save (or cost) lakhs over time.
   
• Akash avoids Bank A because the 14% APR makes the loan too expensive.
   
• Always compare APRs before taking a loan, as it impacts your business profits.

This example shows why smart borrowers like Akash can change our decision because, before taking a loan, you have to carefully analyse the annual percentage rate (APR). Low APR promotes growth, whereas high APR can harm finances.

Conclusion

Understanding APR, or Annual Percentage Rate, is crucial for making wise borrowing choices. Just like Ramesh learned, a loan that seems cheap because of a low interest rate can end up being much more expensive if it has hidden fees that bump up the APR. 

Always check the APR instead of just the interest rate when you're borrowing money, whether it’s for a home, a business, or personal expenses. This simple step can save you a lot of money over time.

Remember, a loan with a slightly lower APR is often better than one with a low interest rate but high fees. Keeping an eye on the APR helps you avoid surprise costs and choose loans that fit your budget.

FAQs

Can APR change after I take a loan?

For fixed-rate loans, APR stays the same. For floating-rate loans, it may change if interest rates go up or down. Always ask your bank if your APR can change.

Why do different banks offer different APRs for the same loan?

Banks charge different fees and have different policies. Some include more charges in the loan, making their APR higher even if the interest rate seems low.

How can I reduce the APR on my loan?

Negotiate fees with the bank, improve your credit score, or compare multiple lenders. Sometimes, offering collateral (like property) can get you a lower APR.

Does APR apply to credit cards, too?

Yes! Credit cards have APRs for purchases, cash withdrawals, and balance transfers. A high APR on a credit card means more interest if you don’t pay the full bill monthly.

What’s a good APR for a personal loan?

It depends on the lender and your credit history. Generally, anything below 15% is decent, but always compare multiple offers to find the best deal.

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LoansJagat Team

We are a team of writers, editors, and proofreaders with 15+ years of experience in the finance field. We are your personal finance gurus! But, we will explain everything in simplified language. Our aim is to make personal and business finance easier for you. While we help you upgrade your financial knowledge, why don't you read some of our blogs?