Introducing How to Money! Episode One: APR
Hey readers, we’ve got some exciting news! We at the OppLoans Financial Sense blog are launching an ongoing video series called “How to Money.” Every episode we’ll tackle a different financial topic. Some of them will be terms you hear every day, while some of them will be a bit more obscure.
Each week, we’ll boil our topic down to its basics and include some helpful tips for how you use your newfound knowledge to live a healthier financial lifestyle. If you’re on the go, these videos will be the perfect way to brush up on your financial know-how.
We’ll be releasing one video a week until, well, until we either run out of financial topics or the sun swells into a gas giant and consumes the planet—whichever comes first.
(Basically, we’re in it for long haul.)
What is APR?
Well, it’s an acronym, and it stands for Annual Percentage Rate. Basically, it tells you how much a given loan or credit card is going to cost you over the course of one year.
APR is a better measure of a loan’s true cost than the simple interest rate because it includes additional fees and charges—something the simple interest rate conveniently leaves out. (You can read more about that in our What You Should Know About Interest Rates blog post.)
Here’s how APR works.
Using the APR, you can figure out how much money you’ll be paying in order to borrow money.
Let’s say you take out a multi-year installment loan for $1,000 with an APR of 15 percent. After one year, you would owe interest equal to 15 percent of the total amount borrowed. In this case, that would mean 15 percent of $1,000, or $150.
So with an APR of 15 percent, you would owe $150 in interest on a $1,000 installment loan after one year.
Here’s where it gets tricky.
Yeah, this is the section where APR gets slightly more complicated. Since APR is calculated off your total remaining balance, the dollar amount that accrues over time decreases, even as the rate stays the same.
Think about it like this: Using the previous example, your APR stays the same at 15 percent, but as you pay the loan down you’re getting charged 15 percent of an ever smaller and smaller balance. If you paid off half of your $1,000 loan, your 15 percent APR would be applying towards a balance of $500, and 15 percent of $500 is only $75.
So what does this mean?
This is actually good for you. As you pay your loan off, the amount of interest that’s accruing goes down too, so you end paying less in interest overall. Less money paid in interest is good! Woohoo!
Using APR for short-term loans…
One of the reasons that APR is such a useful tool is that it lets you compare costs between different loans. And when it comes to short-term loans like payday loans—which oftentimes only last two weeks—APR can show you just how insanely expensive these products are compared to other loans.
Let’s look at the APR for a 2-week payday loan. Let’s say that the loan is for $300 with an interest rate of 20 percent. 20 percent doesn’t sound that bad right?
But, remember, that 20 percent interest rate only applies for the loan’s two week term. If you were to roll the loan over, you’d be charged an additional 20 percent, for a total interest rate of 40 percent over four weeks.
In order to figure out the APR, you have to figure out how much that interest rate would be over an entire year!
There are 52 weeks in a year, and 52 divided by two is 26. So if you multiply 20 by 26, you’d get the APR for your two-week payday loan…
It’s 520 percent.
Yowza! This is why payday loans are so much more expensive than your standard installment loan. The interest rates look comparable, but APR tells you the real story.