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ANNUAL PERCENTAGE RATE

Certainly the finance charge in dollars is a useful amount to know, but interest can be figured using different methods. Often, a consumer does not know how to compare the costs of money. The total finance charge (fees plus interest) divided by the amount financed represents a ratio that can be used to determine the annual percentage rate of a loan, or APR.

Using such a ratio multiplied by $100.00, you will able to determine the cost per $100.00.

Example 1:
Betty Buyer purchases a stereo system for $225.00. She pays the store $25.00 down and finances the rest ($200.00).
She also agrees to pay $20.00 per month for 12 months.
Her finance charge is $40.
The finance charge ÷ amount loaned is $40.00 ÷ $200.00 or 20%.
Betty is paying $20 per $100 for her stereo.

In practice, there are several different ways to calculate the APR. The method used in the examples below is called the simple interest method.

Example 2:
Jim Tree borrowed $1,000 at 10% for one year. He paid a $45 processing fee and $100 in interest. Thus, the finance charge is $145, the interest plus the application fee. Jim calculated the APR for this loan as shown below:

APR = $145 ÷ $1,000 = 14.5%

Example 3:
Tim Worker buys a new sofa for $629.95. He pays 25% down and takes an installment loan to complete the purchase.
He makes 12 payments which include his principal and a $60.00 finance charge. What is the APR on his loan?

Tim will pay $157.49 ($629.95 * 25%) for his down payment.
He will finance $472.46 ($629.95 - $157.49).
Tim will repay $472.46 ÷ 12 plus $60.00 ÷ 12 or monthly payment of $44.37
At the end of one year Tim will have paid $532.44.

The finance charge for one year ÷ amount financed is $60.00 / $472.46 or 12.7%

APR and the Term of a Loan
We rarely encounter simple interest. When we studied compound interest, we learned that by posting interest quarterly a savings account actually earned more than if the interest were posted annually. The same concept applies e ...to debt. The more frequently at any given rate interest is compounded the more actual interest dollars it will produce. The example below is intended to show when that the APR should only be used to compare loans with the same compounding.

Example:
Carl Cornfield has a short term loan at 18% interest per year. He pays the interest monthly and wants to know the annual percentage rate.



Notes:
The percentage is written as a decimal.
The percentage is divided by 12 because it is compounded monthly.y easy to share with others. Click her