# Definition of Annual Percentage Rate(APR)

The Annual Percentage Rate (APR) definition is a standardized way of calculating the interest rate applied to certain types of loans or loan products. It takes into account the interest rate and any additional costs associated with the loan, such as closing costs, origination fees, and other miscellaneous fees. APR is usually expressed as a percentage and is used by lenders to compare different loan options. The APR is usually higher than the corresponding interest rate because it includes these additional costs.

## What is Annual Percentage Rate (APR)?

The Annual Percentage Rate (APR) refers to the annual interest generated by an amount charged to borrowers or paid to investors. The APR is a percentage representing the actual annual cost of funds over the term of the loan or income derived from an investment. This includes any fees or additional costs associated with the transaction, but does not account for compounding. APR provides consumers with a finite number that they can compare between lenders, credit cards or investment products.

### How the Annual Percentage Rate (APR) works

The annual percentage rate is expressed as an interest rate. It calculates what percentage of the principal you will pay each year, taking into account things like monthly payments and fees. The APR is the annual interest rate paid on investments without taking into account the compounding of interest within that year.

### Types of APR

APRs for credit cards vary depending on the type of charge. The credit card issuer may charge one APR for purchases, another for cash advances and a third for balance transfers from another card. Issuers also charge high penalty APRs to customers for late payments or violating other terms of an agreement with the cardholder. There is also the introductory APR – a low or 0% rate – with which many credit card companies try to entice new customers to sign up for a card.

Bank loans usually come with fixed or variable APRs. A fixed APR loan has an interest rate that is guaranteed not to change during the term of the loan or credit facility. A variable APR loan has an interest rate that can change at any time.

APR borrowers are also charged depending on their loan. The rates offered to those with excellent credit history are significantly lower than those provided to those with poor credit history.

### APY versus Annual Percentage Yield (APY)

While the APY takes into account only simple interest, the APY takes into account compound interest. As a result, the loan’s APY is higher than its APR. The higher the interest rate – and to a lesser extent, the smaller the compounding periods – the greater the difference between the APR and APY.

Imagine that the APR on a loan is 12%, and the loan compounds once a month. If a person borrows \$10,000, the monthly interest is 1% of the balance, or \$100. This effectively increases the loan to \$10,100. The next month, 1% interest is charged on that amount and the interest payment is \$101, slightly higher than the previous month. If you hold this balance for the year, your effective interest rate becomes 12.68%. APY includes these small changes in interest expense due to compounding, while APR does not.

Here’s another way to look at it. Let’s say you’re comparing an investment that pays 5% per year to one that pays 5% per month. For the first month, APY equals 5%, as does APY. But for the second, the APY is 5.12%, reflecting the monthly compounding.

Given that APR and a different APY can represent the same interest rate on a loan or financial product, lenders often emphasize the more flattering number, which is why the Truth in Savings Act of 1991 requires disclosure of both APR and APY in advertisements, contracts and agreements. A bank will advertise the APY of a savings account in large print and the corresponding APY in smaller print, given that the former superficially indicates a larger number. The opposite happens when a bank acts as a lender and tries to convince its borrowers that it is charging a low rate. The mortgage calculator is a great resource for comparing both APR and APY on mortgage rates.

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В „Revolving Credit” we looked at what revolving credit is and where it is most applicable. Today, we continue with our analysis of three new financial products, namely the difference between a credit card, an overdraft and a line of credit.

#### How does revolving credit work?

In appearance, credit cards are almost identical to the debit cards we almost all have. With both, you can make purchases both online and in physical stores, but the main difference appears to be the funds available to you.

With a debit card, you use your own money that you have previously deposited with the bank. With a credit card, you borrow money from the card issuer (financial institution) up to a pre-set limit. That is, you are given access to a line of credit and agree to repay the money with interest by a certain date according to agreed terms.

A credit card is preferable to a debit card when you receive your earnings are on different dates, unexpected expenses often pop up, or you want to take advantage of an opportunity (most often some type of offer/promotion) that is time limited but you don’t have enough finances. However, it is important to be disciplined and repay the amount according to the agreed terms so that penalty fees are not charged.

#### What is an overdraft?

An overdraft is a service that allows you to borrow extra money through your current account. It occurs when you don’t have enough money in your account to cover a transaction or withdrawal, but the bank still authorizes the transaction. For example, you have £30 in your account but it costs you £50 to renew your gym card. In this case you use an overdraft and your balance becomes -20 BGN.

In other words, an overdraft is a credit authorization from the financial institution that is granted when your account reaches zero. In most cases, it is agreed and has a predetermined limit which is held as a settled overdraft. It is important to know that fees are usually charged when using this service. Use it wisely as an extra buffer to the amount in your bank account that will allow you to make urgent transactions even when you don’t have the money, not as an amount to rely on each month.

#### What is a line of credit?

A line of credit is a flexible loan provided by a bank or financial institution that, like a credit card, offers you a set amount of money at your disposal – funds you can use when and how you want. Lines of credit are most commonly used by businesses due to working capital needs or to take advantage of strategic investment opportunities when lack of sufficient finance does not allow it.

As with a loan, a line of credit accrues interest as soon as the money is borrowed. However, in the case of a line of credit, the interest payable is charged only on the amount of credit used and not on the entire amount available on the line of credit.

With this type of credit, you can repeatedly withdraw funds and repay them within the pre-agreed period, and of course there are penalty fees if you fail to repay the amount by the due date. There is also a fee for maintaining the line of credit for the duration of the agreement.

#### Which one to choose?

The availability of such a variety of credit products is driven by the different financial needs of individuals and businesses. If you want to rely on your own funds but occasionally fall short, then an overdraft is a sensible choice because you will be able to make your purchases or pay your bills without limiting your budget to a salary. Or if your income varies from month to month, then a credit card may be a better solution because you won’t be relying solely on personal funds as well as paying overdraft fees.

A line of credit is a better option for businesses or individuals with relatively larger financial needs. It is most commonly used for working capital such as purchasing materials, supplies, equipment, payroll, etc.

#### Why Light Finance?

Many people find the credit market confusing. Our goal is to help our customers navigate the loan process by making the entire process as simple and seamless as possible. No complicated jargon or confusing terms, just a quick and easy route to the finance you need without all the complications.

Our specialist team are on hand to help you with any questions or queries you may have about your application. If you’d just prefer to speak to someone rather than complete your application online, give us a call during our office hours and we’ll give you more information about the options available.