
Annual Percentage Rate (APR)  True Measure of Interest Fees Charged by Credit Card Companies Annual percentage rate (APR) is a true measure of the interest fees charged by credit card companies & banks. Annual percentage rate (APR) is the effective cost of credit which is the ratio of finance charges to the average amount of credit used in the life of the loan; this is expressed as a percentage per year. In this tutorial, we look at the calculation of APR for single payment loans & multiple instalment loans. Single Payment Loans A single payment loan is repaid in full on the maturity date and there are two ways of calculating APR on single loan payments: I) simple interest method and ii) the discount method. The difference between the simple interest method & the discount method is what the borrower actually receives in the form of a loan. i) Simple Interest Method Under the simple interest method, interest is calculated on the full original amount borrowed. The formula for simple interest is:
Note that under the simple interest method, the stated simple interest rate & the Annual percentage rate (APR) will be the same. As an example, consider Peter borrowed a singlepayment loan for $5,000 for 2 years, at an interest rate of 8%. The interest charge over the life of the loan (2 years) will be:
Based on this simple interest, what will the APR be?
2) Discount Method Under the discount method, the loan borrower tends to prepay all the finance charges, after which interest is determined & deducted from the amount of the loan. The discount method always gives a higher APR than the simple interest method at the same interest rate because it deducts the total finance charge (total interest paid) from the amount of the loan borrowed. Therefore:
From this calculation, we are deducting the total finance charge of $800 from the loan amount borrowed of $5,000 to arrive at the real loan amount borrowed, $4,200.
We see that the annual percentage rate is actually 9.52% and not the finance charge of 8% as we derived using the simple interest method. Thus, lenders are required to quote 9.52% interest on the loan, and not 8%. This graph shows the effects of the APR of 8% on the $5,000 borrowed principal balance; total simple interest comes out to $800 over a period of 2 years. 
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