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…
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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).
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