Home » What is annual percentage rate (APR)?

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Joel Ohman is the CEO of a private equity-backed digital media company. He is a CERTIFIED FINANCIAL PLANNER™, author, angel investor, and serial entrepreneur who loves creating new things, whether books or businesses. He has also previously served as the founder and resident CFP® of a national insurance agency, Real Time Health Quotes. He also has an MBA from the University of South Florida. ...

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Reviewed by Joel Ohman
Founder, CFP® Joel Ohman

UPDATED: Apr 27, 2012

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Far too many explanations of the APR found online are convoluted, confusing, and will leave inquisitive personal loan borrowers feeling more dumbfounded after reading about APR than when they knew nothing about the term.

APR, which is short for annual percentage rate, is the cost of borrowing money costs when expressed as a yearly rate.

It’s really as simple as that.

But what’s not simple is the calculation for determining APR.

Whether trying to measure the APR on auto, student, home, payday, or personal loans, the same four basic pieces of information must be known in order to determine the APR: principal, interest rate, term, and additional fees.

The first three requirements are pretty self-explanatory, but the additional fees may throw some off. Additional fees can be anything from processing and origination fees to credit checks — whatever extra cost that’s required to give to birth the personal loan a borrower is seeking.

As a quick side note: additional fees only include those that are paid to the lender. Expenses to outside sources, such as appraisal fees or inspections, do not get incorporated into the APR calculation.

Then to determine the personal loan’s APR, one would use an APR calculator.

That’s right, put the pen and paper away, because the APR calculation is simply not worth the time when there are automated ways of discovering the result.

But for the math-masochists out there who are just itching to know the APR formula, it goes something like this:

APR Calculation

Variables

Calculations

A = Principal

B = Additional Costs

C = Interest Rate

D = Term (months)

E = (A / 1200)

F = (C / 1200)

G = Annual Percentage Rate

H = (G / 1200)

First calculate the monthly Payment (P):

P = [(A + B)F (1 + F)D ] / (1 + F)D – 1

 

Then calculate the APR, by using the Newton-Raphson Method

0 = ([H (1 + H)D] / [(1 + H)D – 1]) – (P / A)