Annual equivalent rate (APR)

economic-dictionary

The acronym APR responds to Equivalent Annual Rate or Effective Annual Rate. It offers us a value closer to the reality of the cost (in the case of a loan) or performance (if it is a deposit) of the contracted financial product.

The APR offers us a more faithful value than that revealed by the nominal interest rate (TIN), since it includes in its calculation, in addition to the nominal interest rate, bank expenses and commissions and the term of the operation.

Although we will always have to bear in mind that we are comparing. For example, the APR of a mortgage will always be higher than that of a personal loan with the same nominal interest rate (TIN), because the mortgage usually carries more commissions (study commission, opening commission ...). See difference between TIN and APR.

Therefore, the APR provides us with a more faithful but not exact data, although in its calculation it includes more premises than the nominal interest rate, it does not include all expenses. For example, it does not include notary fees, taxes, funds transfer fees, insurance or warranty fees, etc.

What does the APR tell us?

This means that once you have contracted the deposit, you will know the amount you have invested, the APR of the operation, the expiration date and, putting all this data in common, you will obtain a value that is supposed to be the performance of the operation.

As you can see when the interest is paid, it will be less than the mathematical result you had obtained. Why? For what was explained above, there are expenses that the APR does not include. Nothing is perfect and neither is this going to be. If possible, the bank employee who sold the deposit would have informed you of the exact performance of the operation.

APR formula

The APR formula is as follows:

Where:

  • r: Interest rate of the loan. That is, the nominal interest rate (TIN)
  • f: This is the frequency of payments during a year. If it is paid once a month, in a year, it will be 12 payments (1 payment every month). If it is paid every quarter (three months), it would be paid 4 times a year: f = 4. If it is paid annually: f = 1.

Here is an example of calculating the APR.

Practical example of the APR

Let's use an example of calculating the APR to better understand the distinction between the nominal interest rate and the APR.

Let's imagine that a bank offers us the possibility of contracting a 12-month deposit at an interest rate of 10%, whose interest will be settled after 12 months, at the end of the operation. DEPOSIT TO

Another bank puts an apparently very similar deposit on the table. The only difference is that the interests are paid monthly on the same deposit. TANK B

In DEPOSIT A, the return is € 100 for every € 1,000 invested. In this case, the nominal interest rate coincides with the APR.

While in DEPOSIT B, the yield is € 104.71 for every € 1,000 invested. How can it be? Very simple, because we receive the interest monthly, thus increasing the capital on which we apply the nominal interest rate of 10%, to calculate the interest for the following month (known as compound interest). The formula is as follows. Solving, we obtain an APR for DEPOSIT B of 10.47%, higher than that of A.

r: it is the nominal interest rate (monthly, semi-annual ...) expressed as per one.

f: frequency of interest payments / collections (12 if the rate is monthly, 6 bimonthly, 4 quarterly, 3 quarterly, 2 semi-annually and 1 if annual).

Simple interest

Conclusions about APR

The APR makes it easier for us to compare the financial products offered by banks, which are required by the Bank of Spain to present it in their advertising campaigns.

Of course, let's not be blinded by a higher APR (in the case of deposits or lower in the case of loans). It may be the case that for a few tenths of better APR we have to hire a credit card. This can mean a maintenance expense greater than what we earn for those tenths of the APR. Therefore, it is advisable to read the fine print.

Real interest rate

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