What is APR?

APR stands for Annual Percentage Rate. It is supposed to be a means by which a consumer can fairly compare the cost of borrowing from different institutions.

It is possible for lenders to use all kinds of figures to come up with an interest rate for loans. These deceptive practices caused confusion in the marketplace. So the US government passed the Truth in Lending Act in 1968. This act (among other things) requires lenders to disclose the cost of borrowing in terms of APR. It is not a perfect system because some of the fees may not have to be included in all the calculations, but it is a more accurate estimation of the actual cost of borrowing. It helps the borrower compare rates.

Here is an example:
You borrow $100 at 6% interest. At the end of the year you owe $6 in interest right? Wrong! It seems your lender is compounding the interest every month, and you end up paying interest on your interest so your APR is really 6.17%. The lender is required by law to disclose the APR.

What if this lender also charges a loan origination fee of $10. This extra fee must be included as a cost of borrowing, bringing the APR to 16.78%. This is why the APR is important, it helps the borrower know the true cost of borrowing.

Your lender is also required to give you a “Truth In Lending Disclosure Form” that lays out all the costs of borrowing. Go over this form to see if there are other costs not included in the APR.