How does APR work on a loan?
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Your credit score and other factors determine how likely you are to pay back your money on time. The better this is, the less interest (% extra money) you have to pay on top of the amount you borrowed.
APR is the yearly % interest. However, it typically is compounded (broken up) throughout the year (usually monthly), so the actual effective % change is different, called APY.
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I’ll actually use a saving account that you don’t contribute to as an example because it’s easier.
Let’s say you open up a saving account with $10,000 and a 12% APR compounded monthly; this gives you 1% each month (12%/12 months).
Month 0: $10,000
Month 1: $10,100
Month 2: $10,201
Month 3: $10,303.01
….
Month 12: $11,268.25
$11.268.25 is 12.68% more than $10,000, so it’s a 12.68% APY achieved from a 12% APR compounded monthly (if it was compounded daily then the amount would be even more).
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Let’s make a loan scenario now though:
$10,000 to be paid back in 1yr with a 12% APR compounded monthly.
With 0% interest it would be ~$833.33 every month, with this interest it would be ~$888.49.
If you are allowed to do extra/pre payments and without penalty, for sure do that. Because in Month 1 the amount of the $888.49 that you’d be paying has $100 being just the interest and $788.49 being for the amount borrowed, whereas in Month 12 it is only $8.80 on interest and $879.69 on the amount borrowed.
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