What is APR? – An Introduction

When looking at a loan or finance agreement, you may ask yourself the question “What is Annual Percentage Rate (APR) and is an expression of the amount of interest a loan or other financial agreement will accrue over a one-year period.

What is APR? – Types and Examples of APR

Nominal vs. Effective APR

The simplest example of APR is the nominal annual percentage rate, which is a basic expression of the exact interest rate that a loan will accrue on an annual basis. Calculating the nominal APR involves taking the number of payments a debtor will make in a year and multiplying it by the interest rate percentage.

An alternative framework, the effective annual percentage rate, is a more complicated calculation and varies based on the exact specifications of the loan in question. Generally speaking, the effective APR includes a compound interest rate instead of a flat calculation. The effective APR can vary based on the specific qualities of the loan, more than with a nominal interest rate calculation.

Before considering the answer to “What is APR?” there must be a consideration for the specific qualities of the transaction taking place.

Transactions involving APR

What is APR in relation to common purchases? There are a number of financial transactions that would make use of an annual percentage rate to calculate interest. Regardless of the kind and conditions of the transaction, it must involve an exchange of money over a long period of time, such as with a loan or through financing of a large purchase.

To demonstrate an example familiar to the average consumer, a car purchase would be one example of an exposure to APR. Because most buyers can’t afford to buy a new car outright, they usually have the option to finance their purchase through the dealer’s financing services, or through a third party. Either way, the seller and buyer will usually negotiate a mutually agreed upon level of interest.

You may have noticed many car commercials use their APR as a selling point. For the first few years of ownership, dealers are willing to offer a lower interest rate to entice potential buyers. Those looking to finance a new car should be mindful of the APR both before and after this “grace period”.

Credit cards also feature APR, but only for those carrying a balance. Most credit cards have extremely high rates of interest in relation to other loans, but are required to state their interest rates before they can accept a cardholder. The APR on most credit cards is calculated for monthly payment periods, as this is the standard payment frequency of the industry.

What is APR? – Answering the question

At this point you could probably answer the question “What is APR?” quite easily. Broadly speaking, the annual percentage rate of a loan or other financial transaction describes the amount of interest applied to the outstanding funds during the repayment period. Considerations of APR are important for a number of different purchases, from car loans and mortgages to credit card balances.  An understanding of how APR works is a great step in evaluating a big purchase.

6 years ago