This is a finance charge expressed as an annual rate. APR is intended to make it easier to compare lenders and loan options.
For example, an effective annual interest rate (or APR) of 10% can also be expressed in several ways:
-- 0.7974% effective monthly interest rate, because (1+ 0.7974%)12 = 110%
-- 9.569% annual interest rate compounded monthly, because 12 x 0.7974% = 9.569%
-- 9.091% annual rate in advance, because 1 / (1 + 10%) = 1 - 9.091%
These rates are all equivalent, but to a consumer who is not trained in the mathematics of finance, this can be confusing. APR helps to standardize how interest rates are compared, so that a 10% loan is not made to look cheaper by calling it a loan at "9.1% annually in advance".
The APR does not necessarily convey the total amount of interest paid over the course of a year: if one pays part of the interest prior to the end of the year, the total amount of interest paid is less.
Also, above example does not consider fees. For example, consider a $100 loan which must be repaid after one month, at 5% interest, plus a $10 fee.
-- If the fee is neglected, this loan has a (year-long) effective APR of approximately 79%, since (1 + 5%)12 = 179% = 100% + 79%.
-- If the $10 fee were considered, the interest increases by 10% ($10/$100) for the month, with the effective APR being approximately 435%, since (1 + 10% + 5%)12 = 535% = 100% + 435%.
Hence, when fee is considered, the APR is 435%.
Remember the Harmony Theory we talked about earlier. By using APR, it is now easier to compare lenders and loan options.
