I’m applying for a loan and I was approved at 11.99% but when I went to sign the paperwork it said 12.68%. I asked about it and the loan officer said that it was because of a $50 finance charge that was not interest bearing. I don’t understand how this works…
In: 5
The difference between interest rate and APR is because of compounding. When they quote you the 11.99% interest rate, that means each month you get charged 11.99%/12 = 0.999% interest on what you owe. If you just add up the months, that comes out to 11.99% interest per year. But, that interest charge gets added to how much you owe each month, so the next month’s interest gets charged on the whole amount rather than just what you owed originally.
If you started off the year owing $100 with an 11.99% interest rate, and each month you paid the interest, but nothing on the principal, then at the end of the year you’d still owe $100 and you would have paid a total of $11.99 in interest charges.
If you start off the year owing $100 with an 11.99% interest rate, but you make no payments at all during the year and just roll the interest charges into your loan amount, at the end of the year you’d owe $112.68. That rate of 12.68% is called APR (which stands for annual percentage rate).
What kind of loan is this? The rate seems really high unless it’s for a shady credit card company
11.99% is the APR
12.38% is the APY
The APR is the % that gets divided by how many times it is compounded (calculated) a year, usually monthly or daily.
The APY is the actual total per year. Based on the beginning value and compound interval.
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[I made a calculator in Google Sheets, including payments/contributions](https://docs.google.com/spreadsheets/d/1annrnFwPMdkM_q8VUrzUcyV9OL4ibzRQUMcNiPPcilA/copy), you can play around with it. The default scenario is a 30-year 200,000 mortgage loan at 7% APR, compounded monthly with monthly payments/contributions.
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Scenario:
$100, 120% APR, compounded monthly (120/12 = 10% day each month)
Month 0: $100
Month 1: $110 ($100+ 10%)
Month 2: $121 ($110 + 10%)
Month 3: $133.10
Month 4: $146.41
Month 5: $161.05
Month 6: $177.16
Month 7: $194.87
Month 8: $214.36
Month 9: $235.79
Month 10: $259.37
Month 11: $285.31
Month 12: $313.84
If we compare $313.84 to $100, it comes to ~314% APY, even though the APR was 120%.
APR includes up front charges for originating the loan as your loan officer specified.
You are only paying 11.99% with $50 up front. This is what you agreed to.
The APR tells you that this loan is equivalent to paying a 12.68% interest rate with $0 upfront fees. If you didn’t have that $50 fee then the APR and the base rate would be the same.
APR makes it easy to compare loans with different interest rates and fees.
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