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# How do you calculate credit card apr

By: BankingMyWay.com Staff

By BankingMyWay.com Staff

Many consumers are confused about the function of the annual percentage rate (APR). The APR was created to help make it easier for consumers to compare loans with the same interest rates. The APR represents the “true cost of the loan” by factoring in the cost of loan fees amortized over the life of the loan. The Truth in Lending Act compels lenders to disclose the APR of a loan at closing.

Calculating the APR on a fixed-rate loan is relatively simple if you know the interest rate, loan term and loan-related fees. Loan-related fees include points, pre-paid interest, loan-processing, underwriting, loan document preparation and private mortgage insurances (PMI). Sometimes loan application fees and credit life insurance are also included if applicable.

The first step in the calculation is to add up the loan amount plus all the loan-related fees to determine the adjusted balance. Then use the stated interest rate to calculate the monthly payment on the adjusted balance. The Mortgage Loan Calculator from BankingMyWay.com makes these calculations easy. Finally, reverse solve for the APR using the original balance and monthly payment on the adjusted balance.

For example, consider a \$200,000 30-year loan with an interest rate of 5.5% and \$4,000 in loan-related fees. The monthly payment for the adjusted balance would be \$1,158.29 (\$204,000 at 5.5% over 30 years). By inputting different interest rates into the calculator using the guess-and-check method, you see that 5.68% is the interest rate that produces the closest monthly payment, \$1,158.27. Consequently, 5.68% is the APR. The APR Calculator can simplify these calculations.

Calculating APR on adjustable rate mortgages (ARMs)

is more complex and less exact than on fixed mortgages. Because the rate on adjustable mortgages can change after the fixed-rate period expires, it’s impossible to know precisely what the APR will be over the life of the loan. To get the closest estimation, lenders use the fully indexed rate (FIR) to calculate APR for the adjustable period instead of the stated rate. The FIR is the loan’s index plus the margin.

For example, take a 5/1 LIBOR ARM with a starting rate of 5.5%. It would have a fixed rate of 5.5% for 5 years and then become an adjustable mortgage. On the first adjustment, the rate would change to the index rate plus the margin. The APR assumes this rate based on the current rate of the LIBOR index. If the current rate is 3.725 and the margin is 2.5%, then the adjusted rate would become 6.225%. This rate is used to calculate APR for the adjustable period of the loan. The APR for Adjustable Rate Calculator can perform this calculation for you. Because there is no way to know if the LIBOR index will remain at current levels 5 years from now, the APR calculation is just an estimation.

While knowing the APR of a loan is useful in shopping for the best loan, it should not be the only factor considered. Different lenders use different formulas to calculate APR, so the comparison may not be exact. Some lenders exclude certain fees from their APR calculations. The most accurate way to compare loans is to request good faith estimates from different lenders on loans with the same interest rate and compare loan-related costs item for item.

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Source: www.bankingmyway.com
Category: Credit