What is APR?
What is APR Anyway? Why is it important?
Most of us have heard the term dozens of times, whether it’s the fast talker on the radio ad or the car commercial selling an introductory rate, and many of us just glaze over. Who wants to do math gymnastics while they’re trying to relax and watch their favorite show?
We’re pretty sure that’s exactly what the commercials are banking on. But APR has a huge effect on how much you ultimately pay to borrow money.
Understanding APR doesn’t have to be hard
There are 3 components:
Your APR (Annualized Percentage Rate) is calculated based on the principal amount borrowed and incorporates not only the simple annual interest rate, but also the standard fees you’d pay over the course of a year. Because the APR is annualized, many intermittent or one-time fees (such as origination fees, points, and closing fees) are converted to a yearly cost. All this makes APR a more accurate reflection of the true cost of borrowing money. And, it makes it easier to compare one loan or credit card to another.
Let’s say you’re borrowing $100 at a 10% interest rate, with a one-time processing fee of $5, for a term of 1 year. How would your interest rate compare versus APR?
10% of $100 = $10
Since you’re paying $10 in interest to borrow $100, your interest rate in this case is 10%
10% of $100 + $5 = $15
Since you would pay $10 in interest plus the $5 fee for a total cost of $15, your APR in this case is 15%.
Things to look out for
You may have heard of payday lenders. These are companies that lend money for a short term – and at a high cost. A typical two-week payday loan with a fee of $15 per $100 in principal borrowed leads to an APR of almost 400% (remember, everything is annualized). While it may seem like a small fee at the time, the APR is through the roof!
But payday lenders aren’t the only companies that use strong marketing and creative thinking to squeeze a higher APR out of their customers.
Here are some common examples of how financial services companies find creative ways to charge you, all outside of the simple interest rate:
What’s even trickier is that fees based on your behavior, like late payment fees, aren’t included in the APR because some borrowers never have to pay them. That means that you can’t even factor some of these fees into the true cost of borrowing until they happen!
Why is all this important?
Understanding the APR and the true dollars-and-cents you pay to borrow money is the most accurate way to compare your options, whether you’re considering a loan, mortgage, or new credit card.
It could mean the difference of paying additional hundreds or thousands of dollars just to borrow money. The stakes are high. That’s why car commercials use fast talkers. It’s also why we wrote this blog.
That’s why we keep it simple
At LendingClub, we like to keep it simple: there is a one-time loan origination fee, plus the interest on the loan. Two things. That’s what goes into your APR – no application fees, no prepayment penalties, and no surprises. Get even more details on our Rates & Fees page.
Now that we’ve walked through how APR is determined and why it’s importantthis, aren’t you curious what your APR would be on a personal loan? It (literally) pays to compare the APR for your existing debt to other financing options. Knowledge is power, and just checking your rate won’t impact your credit score. Go for it.