Continuing in our series of financial education posts, we are focusing in this post on APR. In the context of personal loans, APR, or Annual Percentage Rate, is the calculation that the Truth in Lending Act defines as the cost of credit expressed as a yearly interest rate. Importantly, APR includes the interest rate plus any other fees or costs such as origination fees and processing fees.
When you are reviewing your personal loan documents, the Truth in Lending Act actually requires that the lender provide certain information. The loan must disclose the APR, the Amount Financed, the Finance Charge, and the Total Payments.
While APR can be a good guideline for understanding the costs associated with your loan, it is important to use it by comparing apples to apples. For instance, the APR on a 30-year mortgage allows you to compare loans from different mortgage lenders when one has higher interest rates but lower fees, etc.
So, before entering into a loan, here are a few things to consider:
- Check the APR, but understand how the interest rate, the associated costs and fees, and the term of the loan impact the APR calculation. Remember, APR is helpful in comparing different personal loan options and can help you make an apples to apples comparison. APR is not good for comparing different loans when the terms or amounts are vastly different.
- MAKE A BUDGET! We can’t emphasize this enough. Don’t rely on your lender alone to determine if you can afford the loan payments. Look at your gross monthly income, your net monthly income (after taxes), and your fixed monthly payments. After that, you need to be honest with yourself in terms of how much remaining disposable income you have each month.
- Borrow what you need when you need it, but only after consideration of all factors. Personal loans can be very helpful, but make sure you are using the loan for the right reasons.
- Don’t sign a loan until you understand the terms and conditions and the obligations you will have after entering into the loan agreement. It is always appropriate to ask questions if you are not sure about some factor. Highly rated loan companies build trust over time by working with their customers to understand each customers unique financial needs. Make sure the loan company you work with is willing to understand your financial situation.
For more on APR, click here to download the American Financial Services Association brochure entitled Personal Loans 101: Understanding APR.