Explain APR in simple terms

[mendhak]

Let's say I take a loan out for 10,000 GBP. The bank page says it will be at "10.9% APR Typical". Let's also assume that they want me to pay them back over the course of 2 years.

OK - so I looked up APR and as usual, there's an information overload. So I immediately thought, why not ask you guys to explain - in very simple terms - how much I'll be paying back every month and in the long run, how much will I be paying above the 10,000 GBP in interest (which is likely the bank's profit).

Related question - the reason I want to take a loan out is to improve my credit rating. When taking the loan, is actually saying "to improve my credit rating" a valid reason, or do I need to make something up?

[MasterBlaster]

APR is your yearly total. The amount could be different based on your payment schedule/habits.

You should find a better reason to take out a loan than to improve your credit score. Actually, That is probably the stupidest idea I've ever heard so I am going to assume you are joking.

[abhijit]

Skipping the full payment on the credit card statement works faster to improve your credit score, or so I have heard.

APR is the money you have to pay to use money you don't have.


The monthly payment for you could be anywhere between 459 to 461 per month, depending on the rate of compounding. If you're interested, there's a mortgage payment calculator here.

[zaza]

APR tells you your Annual Percentage Rate, ie even though you are paying back every month, this is the number that tells you how much you pay back over the course of a year.

Simplest case, you are compounding the interest in the second year, ie you are not only paying interest on the loan, you are also paying interest on the interest you accrued in the first year.

Year 1: £10,000 x 1.109 = £11,090 = 10.9% more of your £10,000
Year 2: £11,090 x 1.109 = £12,298.81 because you didn't just owe money for the loan at the start of the year, you now owe interest on the interest as well.


You therefore are paying back £12,298.81 in 24 monthly installments = £512.45 per month.
If you just paid back the £10,000 over 24 months, you would be paying £416.67 per month.

Therefore £95.78 per month (£512.45-£416.67) goes to paying your interest. So if you got an interest-only loan, you would pay £95.78 per month for 2 years, and then repay your £10,000 at the end.




But, being a miser, you would point out the following. The above assumes that you owe the full 10.9% on the entire amount for 2 years, and then breaks that down into monthly amounts. But surely, after the first month, you have actually made a payment towards my total, and therefore it is surely unfair to assume that you owe interest on the entire amount for 2 years when clearly you are paying it back. After the first month, for example, you owe £12,298.81 - £512.45 = £11786.36. Some of this has gone to paying off interest, but some of it has gone to paying off the loan.

And you'd be right.


So actually, the payment in month 2 really needs to be recalculated based on how much you now owe, and then you pay off again. And then, in month 3, you have paid off some more so we recalculate again. And so on for 2 years.
By summing up the total of these payments, it's possible to work out how much you have actually paid compared to your loan. That is then used to calculate your APR. Of course, this can all be worked out in advance, assuming a fixed rate, so you can then spread the payments equally still rather than paying a large whack at the start and less as you go on.

[abhijit]

Bankers love to get the large whack at the start, so they can enjoy their rightfully earned Carribean vacations.

[MartinLiss]

Let's say I take a loan out for 10,000 GBP. The bank page says it will be at "10.9% APR Typical". Let's also assume that they want me to pay them back over the course of 2 years.

OK - so I looked up APR and as usual, there's an information overload. So I immediately thought, why not ask you guys to explain - in very simple terms - how much I'll be paying back every month and in the long run, how much will I be paying above the 10,000 GBP in interest (which is likely the bank's profit).

Related question - the reason I want to take a loan out is to improve my credit rating. When taking the loan, is actually saying "to improve my credit rating" a valid reason, or do I need to make something up?

There are a lot of loan calculators available on the web like this one.

[Shaggy Hiker]

You should find a better reason to take out a loan than to improve your credit score. Actually, That is probably the stupidest idea I've ever heard so I am going to assume you are joking.

I doubt it's a joke. I have heard lots of people do this. Nobody I know, though, as everybody I know gets loans for the old fashion reason: Not enough cash.

I don't really like the idea of paying the bank a significant chunk of change (albeit spread over two years) just to get a better credit score. The only reason I have ever heard of doing something like this is when you don't HAVE a credit history. Even in that case, I would prefer to use a credit card (pay off the balance in full each month and it will cost you nothing, unless you are foolish enough to get one with an annual fee), or a series of MUCH smaller loans. I don't think that the size of the loan has as much to do with the impact on the credit score as does the repayment of the loan. So if you are going to pay the bank to inflate your credit score, and can pay them a smaller amount for a larger inflation, why not do so?

[MartinLiss]

Here's an article that may help you.

[baja_yu]

Wait, what's a 'credit rating' and why is actually good to have taken a loan?! Wouldn't it make more sense to have a better rating if you don't have any loans?

[MartinLiss]

Wait, what's a 'credit rating' and why is actually good to have taken a loan?! Wouldn't it make more sense to have a better rating if you don't have any loans?

Actuallly, no. Credit companieds want to see a proven "track record". If you don't have or haven't had any loans your an unknown (= dangerous) risk.

[abhijit]

Wait, what's a 'credit rating' and why is actually good to have taken a loan?! Wouldn't it make more sense to have a better rating if you don't have any loans?

That would be like crowning yourself welterweight boxing champ of the continent without putting on the gloves.

[dclamp]

i opened a student banking account and it came with a credit card, limit of $600. Since i have got it i have been buying things then paying back right away to build my credit. But not everyday things, i bought my $300 books, my $220 parking permit, etc.

[Shaggy Hiker]

That would be like crowning yourself welterweight boxing champ of the continent without putting on the gloves.

Well, that's better than the other way to get that crown.

[Shaggy Hiker]

i opened a student banking account and it came with a credit card, limit of $600. Since i have got it i have been buying things then paying back right away to build my credit. But not everyday things, i bought my $300 books, my $220 parking permit, etc.

$300 for books?!?! What about the other courses you are taking?

Actually, you may find that textbooks are more of a ripoff than you currently think they are. Good professors test from their lectures, with the books being supporting information, at best (except for things like literature classes, of course). In my sophmore semester I spent $60-80 on a biochemistry book and didn't open it all semester. After that, I considered how many pizzas I could buy for that amount of money and never bought another textbook.

[baja_yu]

This is all very new to me. I've never bought a single thing in my life on credit/loan. Never had a credit card either, just a couple of debit cards. I don't like to spend money I don't have.

[MartinLiss]

But some day you may need to and using a card or two that you pay off each month will not only build a good credit rating but it is also safer and more convenient than carrying cash.

[baja_yu]

You're absolutely right. To tell you the truth I'm not sure how credits work in my country, if there even is such a thing as credit rating here.

[MartinLiss]

Care to say where you live?

[baja_yu]

Serbia. Not Cuba as some people assumed

[si_the_geek]

I know what you mean baja_yu, but I use a credit card regularly without that issue - it allows you set up a direct-debit (regular payment by your bank) to pay off the full amount each month, so it is very hard to ever spend money that you haven't got (and it is free to do, because the payment is taken before interest would be charged).

In addition to that it is slightly profitable, because you can leave the money to pay for it in a savings account until the payment is needed (for me it is once a month, from 2-6 weeks after the purchases).

[MasterBlaster]

I doubt it's a joke. I have heard lots of people do this. Nobody I know, though, as everybody I know gets loans for the old fashion reason: Not enough cash.

I don't really like the idea of paying the bank a significant chunk of change (albeit spread over two years) just to get a better credit score. The only reason I have ever heard of doing something like this is when you don't HAVE a credit history. Even in that case, I would prefer to use a credit card (pay off the balance in full each month and it will cost you nothing, unless you are foolish enough to get one with an annual fee), or a series of MUCH smaller loans. I don't think that the size of the loan has as much to do with the impact on the credit score as does the repayment of the loan. So if you are going to pay the bank to inflate your credit score, and can pay them a smaller amount for a larger inflation, why not do so?

Many uninformed people do this. Yes, paying back a loan will increase your credit score. That doesn't make it a good idea. In this case he will be loosing approx 10% each year. Liquid capital and debt to income is worth more to lenders. If he took the money he was going to use to pay back the loan and invest it in something that will make 10% in interest, then current credit score becomes a moot point because he will have collateral to back future loans. On top of that, he gets to keep his interest to re-invest.

Frog, fire your financial advisor.

[dclamp]

$300 for books?!?! What about the other courses you are taking?

Actually, you may find that textbooks are more of a ripoff than you currently think they are. Good professors test from their lectures, with the books being supporting information, at best (except for things like literature classes, of course). In my sophmore semester I spent $60-80 on a biochemistry book and didn't open it all semester. After that, I considered how many pizzas I could buy for that amount of money and never bought another textbook.

Yeah i hear ya. I am majoring in theatre, so about 3 of the books i bought out of the 5 i will probably keep for reference because they are very useful. Hard to explain, but they will be useful to me in the future. My most expensive book this semester is my Theatrical makeup book, $120...

[BackWoodsCoder]

Many uninformed people do this. Yes, paying back a loan will increase your credit score. That doesn't make it a good idea. In this case he will be loosing approx 10% each year. Liquid capital and debt to income is worth more to lenders. If he took the money he was going to use to pay back the loan and invest it in something that will make 10% in interest, then current credit score becomes a moot point because he will have collateral to back future loans. On top of that, he gets to keep his interest to re-invest.

Frog, fire your financial advisor.

I was going to point this out as well. Mendhak, I would talk with your bank and find a way to invest that small loan so you earn money on it rather then lose it. A coworker of mine is doing the same thing to build up some credit to purchase a new vehicle. IIRC he took his loan and put it into a CD.

[MartinLiss]

...In my sophmore semester I spent $60-80 on a biochemistry book and didn't open it all semester. After that, I considered how many pizzas I could buy for that amount of money and never bought another textbook.

Does that explain your user name?

[Shaggy Hiker]

There was a distinct resemblance.

[wossname]

This is the most boring thread in the history of the internet.

[baja_yu]

I have a question for you mortgage lovers. Since I don't know much about the matter except what I've seen on TV shows (and that's that people worry about paying it ). Lets say I buy a house on mortgage that costs $200K for 15 years. What happens if I decide to move to a new house before I pay off the mortgage? Do I have the right to sell it? For how much and what happens with the remaining payments?

[TheBigB]

If you move to an equal value house you basically transfer the mortgage.
Higher value you can expand your mortgage.
Lower value, transfer + profit.

[baja_yu]

Do you have to arrange the purchase (new) and sale (old) at the same time then, or do you have to sell the old one first? Since you are basically upping (if moving to a more expensive) the bank handles everything, right?

[dbasnett]

In code, if that helps:

        Const rate As Decimal = 10.9D
        Dim iprin As Decimal = 10000 'initial principal
        Dim r As Decimal = rate / 100D / 12D 'monthly interest rate
        Dim n As Integer = 2 * 12 'period of loan in months

        'payment = (iprin * r * ((1 + r)^n)) / ((1 + r)^n - 1)
        Dim rPlus1ToN As Decimal = CDec((1D + r) ^ n) 'substitue for (1 + r)^n in formula

        Dim payment As Decimal = (iprin * r * rPlus1ToN) / (rPlus1ToN - 1) 'calculate monthly payment
        Debug.WriteLine(payment.ToString("C2"))

        Dim repaid As Decimal = n * payment 'show amount repaid
        Debug.WriteLine(repaid.ToString("C2"))

        Dim interestPaid As Decimal = repaid - iprin

        Dim Effinterest As Decimal = interestPaid / iprin

        Debug.WriteLine(Effinterest.ToString("P2"))

[dbasnett]

Do you have to arrange the purchase (new) and sale (old) at the same time then, or do you have to sell the old one first? Since you are basically upping (if moving to a more expensive) the bank handles everything, right?

They are separate transactions. Until your old house is sold you are responsible for the payments. If it sells for less than what you owe (principal) you are responsible for that also.

[FunkyDexter]

Do you have to arrange the purchase (new) and sale (old) at the same time then

In legal terms, no. In practical terms, probably yes. You could sell before you buy but then you're going to be homeless for the interim. You could buy before you sell but yoour credit rating is unlikely to be good enough to get two concurrent mortgages. What happens in reality is that 'chains' of movers form who all agree to move on the same date.

Do I have the right to sell it?

Technically it's owned by the bank until you've paid the mortage in full and they hold onto the deeds. That said they're very unlikely to prevent you from selling so long as it's not going to leave you with an unnafordable shortfall on the mortgage. As long as you'll be able to pay them off they're not going to care. Assuming you're not transferring your mortgage to another property you might incur some early repayment penalties.

[MasterBlaster]

Do you have to arrange the purchase (new) and sale (old) at the same time then, or do you have to sell the old one first? Since you are basically upping (if moving to a more expensive) the bank handles everything, right?

No, you are required to pay the entire loan back if you sell. If you sell for more than you owe on the loan, you get to keep the remaining profit(equity) If you sell it for less than what you owe, It's called a short sale and you will need the banks consent. You can also rent out the property, or set up a lease to own option and sell it at a later date. The later will increase the interest rate of your second mortgage regardless of credit score. However, the banks will feel more comfortable financing a second house if the other house is generating income.

[Hack]

I can't believe you people.

33 posts in this thread and not one of you has mentioned the obvious...that APR is the abbreviation for the 4th month of the year.

I am sooooooooooooo disappointed in the lot of you.

[Shaggy Hiker]

Yes, it was clearly an oversight. You might even call it A PR blunder.

[FireXtol]

Hire an accountant. You're clearly too 'tarded(what the youngsters would say) to do math.

[Siddharth Rout]

If you are getting a loan, then your credit rating is already good enough....

I agree with MasterBlaster and Shaggy. Since I am working with a UK Debt Management company, I understand how a UK Credit Rating works... It is unwise to pick up such a huge loan just to increase your credit rating.

I am sure you do your shopping every month... you have a mobile etc... That's good enough to boost your credit rating... If you want, get a store card from Next/Mark and Spencer/Little Woods

You now have 3 Things to boost your credit rating without paying EXTRA Interest...

1) Your Credit Card
2) Store Card
3) Mobile Bills (Contract)

For Credit Card and Store Card ensure that you not only clear the balance every month but leave a small positive balance in them as well.

For mobile bill if possible pay Double your monthly bill. For example if your monthly bill comes to 40 pounds then pay 80. If you do this thrice or four times, you will see your credit limit increase for your mobile bill which is also a clear indication of your overall credit rating

[Maven]

So I immediately thought, why not ask you guys to explain - in very simple terms -

And here I thought you were asking about the Apache Runtime Library.

[InvisibleDuncan]

No, you are required to pay the entire loan back if you sell.

Technically true (the loan is secured on the property, so you are required to keep the property for the duration of the loan), but as Funky said, you're more likely to take the mortgage with you if moving from one house to another. If you change mortgage providers when you move, you will probably have early redemption penalties to pay on the first mortgage, but you can sometimes wangle a deal whereby your new provider will pay those penalties for you. Of course, they'll probably just add the amount onto your mortgage...

I paid my mortgage off in its entirety earlier this year, and that was a great feeling.

[FunkyDexter]

For Credit Card and Store Card ensure that you not only clear the balance every month but leave a small positive balance in them as well.

I've never heard that before. Do you know what the thinking behind this is? I thought both types of card worked on the premise that you'll run up a managable debit and clear it regularly (usualy monthly) rather than run in credit.