Annual Percentage Rate (APR)
APR is used for finance and has always been a bone of contention because:
- No one really understands it – including most financiers,
- The calculation can be different for the many types of repayment terms available.
Flat Rate
Basically, on a loan of £100 with a total repayment of £110, this would mean a ‘flat rate’ of 10%.
APR
If you had a lease for a car and there was a broker fee payable to the car dealership from the price of the car included in the lease repayment agreement, there are two items:
- the car
- the broker fee
Therefore, the car is the only part of the lease that truly attracts interest. As the fee to the broker is not counted in the lending equation of APR, it in effect increases the interest rate for the remaining part – the car. The APR must also take into account ‘compound interest’, as the amount periodically being repaid reduces the overall balance meaning that the true rate of interest changes with each repayment amount.
The following formula enables the APR to be determined by taking into account both the total charges the borrower has to pay and the time at which the loan and charges are paid, so that the borrower knows how much annually, in percentage terms, he is paying for the use of the money borrowed.
The example below shows how the formula would be used to calculate the APR for a £1,000 loan, which is repaid in a single amount, with charges of £200, after one year.”
In the following example, we will let a = APR
| £1000 | = |
£1200 |
|
(1 + a) |
||
| 1 + a | = | £1200 |
| £1000 | ||
|
1 + a |
= |
1.2 |
|
a |
= |
1.2 – 1 |
|
a |
= |
0.2 |
| APR | = | 20% |
|---|
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