A personal loan can be a viable solution when you need financial assistance for various purposes like home renovations, medical emergencies, or debt consolidation. However, before you apply for a personal loan, it’s crucial to understand the two key aspects that determine the cost of borrowing: the Annual Percentage Rate (APR) and the interest rate.
What is APR on a personal loan?
The Annual Percentage Rate (APR) is a comprehensive representation of the total cost of borrowing over a year, expressed as a percentage. Unlike the interest rate, which solely considers the interest charged on the loan amount, the APR includes other associated charges such as processing fees, prepayment penalties, and any additional costs incurred during the loan tenure.
The APR helps borrowers understand the actual loan cost, enabling them to compare different loan options more easily.
What are interest rates on personal loans?
If you take out a personal loan, the lender will add an extra charge to the borrowed amount called an interest rate. This rate is a percentage that represents the cost of borrowing funds, and it is usually calculated monthly or yearly. The interest rate is a crucial factor influencing your monthly or equated monthly installments (EMIs).
A lower interest rate translates to lower monthly repayments and vice versa. Remember that the interest rates may differ depending on your income, credit score, and the lender’s policies.
Difference between APR and interest rates on personal loan
APR:
Comprehensive cost: APR represents the total cost of borrowing over a year, including the interest charged and other fees associated with the loan.
Inclusion of additional charges: APR incorporates additional costs such as processing fees, origination fees, closing costs, and prepayment penalties, giving a more accurate reflection of the overall borrowing expenses.
Comparison tool: APR allows borrowers to compare different loan options from various lenders, considering the complete cost of the loan.
Transparent representation: APR provides transparency by disclosing all charges associated with the loan, helping borrowers make informed decisions and understand the cost of borrowing.
Interest rate:
Cost of borrowing: The interest rate represents the cost of borrowing the principal amount from the lender, expressed as a percentage.
Excludes additional charges: When calculating the interest rate on a loan, only the interest charged is considered, and not any other fees or charges on the loan.
Monthly repayment calculation: The interest rate calculates the monthly or equated monthly installment (EMI) the borrower must pay.
Affordability indicator: The interest rate helps determine the loan’s affordability by influencing the monthly repayment amount. A higher interest rate results in higher EMIs, while a lower interest rate leads to lower EMIs.
To wrap up
While applying for a personal loan, it is essential to consider both the Annual Percentage Rate (APR) and the interest rate to understand the cost of borrowing. Using a personal loan EMI calculator and considering the APR and interest rate, you can evaluate the loan’s affordability and choose the best option for your financial needs.
