What is Annual Percentage Rate (APR) and How APR is Calculated

When you take a loan or use a credit card, you probably look at the interest rate first. But have you ever noticed the term APR and wondered what it actually means? APR or Annual Percentage Rate goes beyond just the interest rate — it shows the true cost of borrowing, including extra fees and charges you might not think about. 

Here, we’ll break down APR in the simplest way possible like what it is, how it’s calculated, why it matters and what the RBI says about it. Read on to know more!

What is Annual Percentage Rate (APR)? 

APR is not just the interest rate on your loan – it’s the full picture of what you’ll pay yearly to borrow money. It includes the interest plus all other loan-related fees like processing, verification, and maintenance charges. 

As per RBI’s 2022 digital lending guidelines, APR is the effective annual rate that reflects the total cost of borrowing. It covers costs like interest, credit and operating expenses, but excludes penalty charges such as late fees or EMI bounce charges. 

Key Points to Know About APR When Borrowing a Loan  

Based on the annual percentage rate definition, take note of the following pointers about the APR for a loan you borrow: 

• It’s shown as a yearly percentage for easy understanding. 

• It reflects the total cost of your loan, not just the interest. 

• It includes all mandatory charges tied to your loan. 

• It doesn’t include penalties for late payments or defaults. 

• It helps you compare loan offers accurately. 

RBI Mandates Two Key Facts About APR 

Below are the 2 things RBI wants you to know about APR: 

• Annual Percentage Rate and Insurance 

Insurance charges are considered when calculating a loan’s APR only when insurance is linked to the loan. Assuming you are taking a home loan where the insurance component integrates into the loan, only then are lenders adding it when computing the APR.  

• Annual Percentage Rate for Loans with a Floating Interest Rate 

When it comes to loans with rates that fluctuate based on market conditions, the APR will change too. In such cases, the RBI mandates that lenders need to include the APR. It considers the current rate of interest in the Key Fact Statement at the time of loan origination. When a revised APR applies, lenders need to share this figure with borrowers via further communication at the applicable time.  

Types of APR 

Here is a brief collection of some common types of APR rates in India: 

• Fixed APR: In this type, the interest remains fixed throughout the tenure of the loan. 

• Variable APR: In this type of APR, the interest rate can vary depending on the repo rate or the market fluctuations.  

• Credit Card APR: In this type, the interest rate is charged over the outstanding amount or cash advance, specifically over credit cards.  

• Purchase APR: In this type, the interest rate is applicable over the purchases or expenses made through a credit card.  

• Cash Advance APR: If a cash withdrawal is made using a credit card, the cash advance APR will be applicable.  

• Balance Transfer APR: Balance transfer APR means the interest rate is applicable when the amount is transferred from one credit card to another.  

• Nominal APR: Nominal APR means interest without extra fees and compounding. It applies to all types of loans.  

• Effective APR: This means the interest applicable on all types of loans, including fees, additional costs, compounding, and cost of borrowing.  

Difference Between APR vs. APY 

The APY rate is the annual percentage yield rate. It is primarily applicable to investments. According to the new RBI regulations, you should get this information when you invest online. Also, you should double-check the Key Fact Statement to ensure there are no misunderstandings.  

Parameters	APR (Annual Percentage Rate)	APY (Annual Percentage Yield Rate)
Definition	Amount of interest applicable on amount borrowing and credit	Amount of interest earned within a financial year as an investor
Compound Interest	It does not add compound interest to the calculation	It adds compound interest to the calculation
Interest rate	The interest rate must be lower when borrowing	The interest rate should be higher as you earn it
Calculation	Includes additional fees like lending fees, processing fees, and settlement charges	APY does not consider any additional fees
Influenced By	APR can fluctuate due to market conditions	APR can also fluctuate due to market conditions

Remember, both terms are important, and you will come across them when applying online. However, the APR gives you a holistic view of the undertaking. This is why you must compare the APR for various loan offers to know which one suits your capabilities best. The APR helps you arrive at the real cost of borrowing credit.  

Also Read: APR Vs APY Differences: A Comprehensive Guide 

How Annual Percentage Rate Calculator Works?  

You can calculate it by using a free digital calculator or by doing it manually. All you will need is to have the key values of the loan, which are: 

• Principal amount 

• Loan tenure 

• Interest rate or total interest payable 

• Associated fees 

To know the fees payable, check with your lender. Sometimes, these charges are a percentage of your loan amount, while some lenders may levy a flat charge. No matter the expression, you can simply input the values and get an accurate result.  

The manual APR calculation formula is as follows: 

APR = [{(Fees + total Interest)/ Principal}/ n] * 365 * 100  

Where, ‘n’ is the number of days, as per the tenure.  

Here is an example: Consider a loan of ₹1,60,000 with the total interest payable as ₹24,000, a tenure of 24 months and associated fees of ₹6,000.  

• Step 1: Add the fees and the total interest payable, which comes to ₹30,000.  

• Step 2: Divide these results by the loan amount, which is (₹30,000/₹1,60,000) and this comes to 0.1875.  

• Step 3: Divide this value by the tenure in days, which is 0.1875/730.50 and this comes to 0.0002566.  

• Step 4: Multiply this value by 365, and then multiply the result by 100, which is (0.00018822365)100, and this comes to an APR of 9.365%.  

As you may have noticed, the APR equation requires you to convert values for accuracy, and this alone can be a tedious process. This is why using online calculators is often the easiest route to take.  

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FAQs on APR Calculation 

Is APR better than interest rate?  

APR overall represents the interest rate of your account as a borrower. It consists of all additional fees and charges, which include interest rates. Knowing more about APR will help you understand the final cost of borrowing other than just interest rates.  

What per cent of APR is good for a personal loan? 

A fair APR can be 6%-10%, but it can depend on your finances and the lending climate. Instead of focusing on a figure, analyse the APRs of various personal loans and choose the most affordable one based on your repayment ability.  

Does APR matter on a personal loan?  

Yes. APR matters on a personal loan as it includes all additional charges along with the interest rate of your loan.  

What is the highest APR for a personal loan?  

The APR of personal loans fluctuates based on the interest rate offered by the lender, along with other charges applicable to the loan. However, the APR value can go up to 44%.  

How do you convert APR to the interest rate?  

When you remove the other loan charges from the calculation of APR, you will arrive at the interest rate. However, it is best to simply check the interest rate by asking the lender.  

How to estimate APR?  

To get an estimate of the APR, use the following formula: APR = [{(Fees + total Interest)/ Principal}/ n] * 365 * 100. Here, n is the number of days. First, add the fees and interest rate payable and then divide this amount by the total loan amount. Then, divide this value by the tenure in days. You need to multiply this value by 365 and, finally, multiply the value by 100.  

How to calculate APR from the interest rate?  

You can simply calculate APR from the interest rate by multiplying the periodic interest rate by the days of total loan tenure.  

How does APR measure the true cost of a loan?  

Annual percentage rate (APR) measures the true cost of a loan since it takes into account the interest rate as well as other costs associated with borrowing the amount.  

What is APR on a credit card?  

APR on a credit card refers to the interest applicable on a credit account. In simple words, it is interest that you pay on credit cards when there is an overdue balance. You can calculate it using this formula: Credit card interest = [daily rate] x [total daily balance] x [number of days in billing cycle].  

How APR is calculated monthly?  

To calculate your monthly annual percentage rate (APR), find the current APR and divide it by 12. This will give you your monthly periodic rate. Then, multiply this amount by the current balance of credit to get the monthly APR.