Most people will need a loan for one reason or another, at some point during life. Loans these days are complex banking instruments that can often be difficult to comprehend. The APR is designed to help in the lending and selection process when choosing a loan. Find out the basics about what is APR before you make a loan selection.
What is APR? The APR (or annual percentage rate) refers to an expression, in percentage, of a standardized rate for a given loan across a year. The APR takes into account all the necessary fees that are associated with the loan. The APR developed as a tool to compare two or more loans accurately — as in comparing apples to apples and pears to pears.
How long has APR been used? The Federal Truth in Lending Act (TILA) was enacted in 1968 and implemented by the Federal Reserve through a series of regulations. Investopedia explains that the purpose of this law was to protect and educate the consumer when dealing with creditors and lenders, the various loans and their details. The Truth in Lending Act’s most crucial feature dealt with the disclosure of the full terms and costs of the loan by lenders to borrowers upfront.
Why is APR used? The Truth in Lending Act regulates what can be said and advertised in reference to any given offer of credit. Banks and other companies may not hide fees or overly complicate the description of a loan, but must fully disclose the full cost, over a year, of the credit offered. This disclosure (APR) was necessary due to the rampancy of consumer confusion and disingenuous credit offers.
What are APR pitfalls? While the APR is considered a standardized rate for fair loan comparison, it can be misleading. APR standardization is variable. That is to say that there are many types of APR and these types are not yet standardized, states the “White Paper: The Lost Art of Interest Calculation.” Types of APR include U.S. Rule, nominal, actuarial, effective, real and historical. While standardizing the APR is a goal for some in the United States, it is not widely desired for fear of further confusing the consumer. Europe imposes a standard where the true APR must be the effective APR, taking into consideration all the fees as well as the compounding period — also known as the APY or Annual Percentage Yield (the true interest rate).