Annual Percentage Rate & Annual Percentage Yield
Typically, when borrowing money or using credit, interest is accrued in the form of an annual percentage rate, also known as APR. The annual percentage rate is the annual rate that is charged for borrowing money or making purchases on credit. It can also represent the amount of money made from an investment that has interest applied. The APR is expressed as a single percentage number that represents the actual yearly cost of funds over the term of a loan or use of credit. This rate includes any fees or additional costs associated with the transaction.
Why Knowing The APR is Important
Being able to calculate the interest accrued on borrowed money is essential in making sure that you have the capacity to repay it, won't over extend yourself, and know exactly how much time it would take to payoff a debt as well as how much money is going towards interest and principle, where principle is the balance of borrowed funds and interest is the cost associated with borrowing said funds. Often times, we're uneducated on this matter and wonder why our loan balances never decline yet never really dig for the answers to this issue.We move to say that if most people knew the true cost of borrowing money that they would likely think twice before signing on the dotted line and seek alternative options.
Other peoples money or OPM can be a great way to leverage your resources and avoid spending more money out of pocket initially, but the key to borrowing money or using credit is to be knowledgeable of what terms are in place, how much money is required to pay off your liabilities and give you the piece of mind to be able to accurately assess the implications of credit and borrowed money. Deeper Understanding of the Annual Percentage Rate – APR


Generally speaking, loans and credit agreements will vary in regards to interestrate structure, transaction fees, late penalties and other factors. As such, a standardized computation such as the APR provides borrowers with a bottomline number in which they can use to easily compare rates charged between potential lenders.
By law, credit card companies and loan issuers must show customers the APR to aid in a clear understanding of the actual rates applicable to their agreements. Credit card companies are allowed to advertise interest rates on a monthly basis, for example 2% per month, but are also required to clearly state the APR to customers before any agreement is signed. So be sure to read the agreement thoroughly before committing to it. A credit card company might charge 1% a month, but the APR is 1% x 12 months = 12%. It is important to note that the APR differs from the annual percentage yield (APY), which is a computation that also takes compound interest into account. We recommend you use the APY to calculate future payment amounts. Some lenders have a tendency of using the difference between the APR and APY to make the percentage seem more appealing so beware of this. APR is based on simple interest while APY is based on Compound Interest.
By law, credit card companies and loan issuers must show customers the APR to aid in a clear understanding of the actual rates applicable to their agreements. Credit card companies are allowed to advertise interest rates on a monthly basis, for example 2% per month, but are also required to clearly state the APR to customers before any agreement is signed. So be sure to read the agreement thoroughly before committing to it. A credit card company might charge 1% a month, but the APR is 1% x 12 months = 12%. It is important to note that the APR differs from the annual percentage yield (APY), which is a computation that also takes compound interest into account. We recommend you use the APY to calculate future payment amounts. Some lenders have a tendency of using the difference between the APR and APY to make the percentage seem more appealing so beware of this. APR is based on simple interest while APY is based on Compound Interest.
Simple Interest & Compound Interest
Simple interest is called simple because it overlooks the effects of compounding. The simple interest charge is always based on the original principal, so interest on interest is not included. This method may be used to find the interest charge for shortterm loans, where compounding is less of a factor.
To determine simple interest multiply the interest rate by the principal and then by the number of periods.
Simple Interest = (P)(I)(N)
Where:
P is the loan amount
I is the interest rate
N is the duration of the loan, using number of periods
To determine simple interest multiply the interest rate by the principal and then by the number of periods.
Simple Interest = (P)(I)(N)
Where:
P is the loan amount
I is the interest rate
N is the duration of the loan, using number of periods
Compound interest is interest that accrues on the initial principal and the accumulated interest of a principal deposit, loan or debt. Compounding of interest allows a principal amount to grow at a faster rate than simple interest, which is calculated as a percentage of only the principal amount so it is wise to use the compound computation to determine the true cost of borrowing money.
The more frequently interest is added to the principal balance, the faster the principal grows and the higher the compound interest will be. The frequency at which the interest is compounded is established at the initial stages of securing the loan. Usually, interest tends to be calculated on an annual basis, although other terms may be determined at the time of the loan.
Calculating Interest When Principal, Rate and Time are Known:
$5,500.00 at 8.5% for 5 years
Interest (I) = Principle (P) x Rate (R) x Time (T)
I = (5,500)(0.085)(5)
I = $2,337.50
When you know the principal amount, the rate and the time, the amount of interest can be calculated by using the formula:I = (P)(R)(T)
For the above calculation, we have $5,500.00 to borrow (or invest) with a rate of 8.5% for a 5 year period of time.
Knowing the concepts and formulas above can save you months and years of heartache  avoiding outrageous interest fees and monthly payments, and better understanding the terms of an agreement to borrow money or use credit. Make it a habit to practice your understanding of loan terms before you ever sign on the dotted line. You'll be extremely happy you did.
The more frequently interest is added to the principal balance, the faster the principal grows and the higher the compound interest will be. The frequency at which the interest is compounded is established at the initial stages of securing the loan. Usually, interest tends to be calculated on an annual basis, although other terms may be determined at the time of the loan.
Calculating Interest When Principal, Rate and Time are Known:
$5,500.00 at 8.5% for 5 years
Interest (I) = Principle (P) x Rate (R) x Time (T)
I = (5,500)(0.085)(5)
I = $2,337.50
When you know the principal amount, the rate and the time, the amount of interest can be calculated by using the formula:I = (P)(R)(T)
For the above calculation, we have $5,500.00 to borrow (or invest) with a rate of 8.5% for a 5 year period of time.
Knowing the concepts and formulas above can save you months and years of heartache  avoiding outrageous interest fees and monthly payments, and better understanding the terms of an agreement to borrow money or use credit. Make it a habit to practice your understanding of loan terms before you ever sign on the dotted line. You'll be extremely happy you did.