Chapter 2. What is APR?

APR is the Annual Percentage Rate. You may be wondering why we did not include the APR in our discussion of rates in the first chapter. This is because it is more complex!

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How to

APR is a broader measure of the cost to you of borrowing money. It is tied to the Prime Rate and includes fees and other charges. In the case of getting a mortgage, a loan, or a credit card, the APR reflects many aspects: the interest rate, the points, the mortgage broker fees, and other charges that you have to pay to get the loan are some of the facets that the APR reflects. For that reason, APR is usually higher than your interest rate. APR is also known as the published or listed rate for loans. It is the percentage of interest a bank or other loan provider charges each year when you borrow any amount of money.  This percentage can help you accurately gauge how much you will pay throughout the lifetime of a loan. By law, all financial institutions are required to show you a loan's APR. As such, it is important you compare APR's of various loans before you make financial borrowing decisions.

Have you ever wondered how credit card lending companies calculate your interest due each month? They divide the APR for each credit card by 365 days for the year to derive the daily periodic rate or DPR. Then, they multiply DPR times the days in a billing period times balance to calculate your interest due each month. This is the main reason credit companies want you to pay only the minimum required payment to stretch your payments over a longer period of time. The longer it takes you to pay your debts, the more profit the lending institutions gain over time. It should be easy to recognize the need for you to pay your credit card debt in full and on time each billing cycle...to avoid wasting your hard earned money on interest. 

 

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Think of the money that you can save which you are then able to invest and earn compounded interest on in return. This is, in a nutshell, the wisdom of the Time Value of Money.

 

Practice

Now that you know the secrets of the Annual Percentage Rate, think of paying it forward and discuss your experience with a friend or a family member.

 

Congratulations! You can move on to Chapter 3. What is amortization?

To review the full module on Time value of money, click here.