How Is an APR Calculated?

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How Is an APR Calculated?

If you've ever looked into borrowing money or applying for a credit card, one of the most confusing numbers that will pop up is the Annual Percentage Rate, or APR.

What does this number signify, and what is the calculation that goes into it?

The interest rate of financing is what your lender charges you as interest. The APR is the interest combined with any other fees involved, including points, commissions, origination fees, or other charges through the life of the loan, divided into an annual rate.


Suppose you lend your friend $300 for a year at 10% interest. At the end of the year your friend will owe you $300 (initial amount) + (300 x 10% interest) = 300 + 30 = $330. Now, 30/300 = 0.10, so the APR is 10%. This is a one-year loan at an interest rate of 10% and an APR of 10%. Notice that the APR is the same as the interest rate because you didn't charge your friend any fees other than interest.

Suppose you added a $10 "processing fee" on top of your interest. In this scenario, you'll be lending your friend $310. With the same 10% interest, your friend will owe you $310 (initial amount) + (310 x 10% interest) = 310 + 31 = $341. 31/300 = .103, so the APR is 10.3% and the interest rate is 10%.

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You receive a $10,000 loan with 10% interest for one year. In addition, you also must pay a 4% origination fee. 4% of $10,000 is $400. $400 is added to your loan, so the amount becomes $10,400. At the end of the year, you'll owe $10,400 (loan amount) + $1,040 in interest ($10,400 x .10). The total amount you owe becomes $11,440. $1,440 divided by $10,000 is .144, so your APR is 14.4%.


Lenders are required to provide you with the terms of your financing, which includes your interest rate and APR. Most providers will give you a range of both - for example, you'll see an advertisement for a loan that makes a note somewhere: "actual rates may vary depending on credit factors. Interest rates range from 7.70% - 14.95%."

For some types of loans, you'll need to be wary of teaser rates where lenders state that you will have a low interest rate or APR (sometimes as low as 0%), but after your "introductory period" your rate will rise significantly.

As with any large financial decision, make sure you ask the right questions before making a final choice.

Originally published October 9, 2017.