Archive for February, 2010
APR on Personal Loans: Why it Doesn’t Matter
If you’ve ever shopped for a personal loan, credit card, or mortgage, chances are you’ve heard the term APR, or Annual Percentage Rate. But what does it mean? And why doesn’t it matter when applying for personal loans like payday, installment, and/or car title loans?
Because, according to investorwords.com, “Annual Percentage Rate is the yearly cost of a loan, including interest, insurance, and the origination fee, expressed as a percentage.”
So why isn’t APR appropriate for determining the cost of a personal loan? In order to find the answer to that question, you don’t need to look any further than the term’s first word, which is Annual. Personal loans such as payday, installment, and car title loans ARE NOT annual loans, they are weekly and monthly loans. As such, these loans have weekly and monthly costs, NOT yearly costs. Therefore, annualizing these costs are not an accurate way of determining how much these personal loans will cost you. In fact, the only reason lenders display these inaccurately inflated APRs is because it is illegal not to.
So, how can you accurately determine what payday, installment, and title loans will cost you?
You simply calculate the cost per hundred dollars borrowed (interest), and then divide it by the original amount borrowed (principal) in order to find the interest rate. This is our Loan Cost Calculator, and the formula can be found below:
Cost of Borrowing/Amount Borrowed = Interest Rate of Loan
The lender is required by law to tell you the cost per hundred dollars borrowed, and that cost is usually how much it costs to borrow the money for 2 weeks. However, if you need to borrow for more than 2 weeks, simply divide the cost by 2 weeks and then multiply that cost by the number of weeks you need to borrow the money. For example, if you need to borrow for 3 weeks but the lender posts it’s rate per $100 borrowed in 2 week terms, your calculation would look like this:
(Cost of borrowing / 2 weeks) * 3 weeks = Cost of borrowing for 3 weeks
For example, if you borrow $100 for 2 weeks, and it costs $15 to borrow $100 for 2 weeks, you would calculate the cost of the loan as follows:
$15 (cost of borrowing for 2 weeks)/$100 (original amount) = 15% interest rate.
$100+$15 = $115 Total Repayment with principal and interest.
If you borrow $100 for 4 weeks, you would calculate the loan cost as follows:
$30 (cost of borrowing for 4 weeks)/$100 (original amount) = 30% interest rate.
$100+$30 = $130 Total Repayment with principal and interest.
Now let’s calculate the cost of a $500 loan for 2 weeks, and it costs $20 to borrow $100 for 2 weeks:
$100 (cost of borrowing for 2 weeks)/$500 (original amount) = 20% interest rate
$500+$100 = $600 Total Repayment with principal and interest.
So there you have it. Remember, payday, installment, and title loans are given for weeks and months, not years, so that means that APR calculations do not apply to them and are inaccurate in determining their costs. Hopefully this article and our Loan Cost Calculator formula will help you accurately determine the true cost of your next personal loan.
