The actual annual interest rate is an indicator that allows borrowers to quickly compare the costs of loan offers. Although the intentions behind the creation of the APR were right, in practice few people use this tool.
The presentation of the APRC in both credit agreements and in consumer credit advertisements (including non-bank loans) is obligatory. Despite this, few potential borrowers attach importance to the final value of the APRC. When comparing offers, customers continue to suggest installments, interest rates or commissions. It is a pity, because APY is a valuable information carrier that allows you to easily estimate the profitability of a loan or loan.
How do the banks calculate the APRC?
The actual annual interest rate should take into account all the basic costs that the borrower will incur in connection with the conclusion of the loan agreement. We include mainly due interest, commissions and insurance premiums (in the case when the borrower decides to buy an additional policy). However, the APR does not include additional charges, such as possible costs of reminders sent to the customer due to delays in paying installments, credit card fees or account servicing, which the borrower has opened to make it easier to settle accounts with the bank.
It’s not only costs, but also time
If the APY depends on a few well-known elements, then why in some cases its height reaches astronomical values? Analyzing loan offers, you can come across proposals from APY that reaches several hundred or even several thousand percent? All because of the fact that in addition to the previously mentioned credit costs, the value of money over time is also taken into account.
In other words, the indicator includes the period during which we can have the amount borrowed. And so the APY for a loan with the same parameters can amount to several percent, when the repayment takes place after a few years or even several thousand percent, when the payment deadline is reduced to a month.
Why is the APRC higher than the nominal interest rate?
The repayment frequency of the APR also has a significant impact on the amount of the APRC indicator. Assuming that the interest rate on the loan is its only cost (the bank does not charge commissions or other fees), repayment of the liability in installments will result in the APRC being higher than the nominal interest rate. Both values would be equal only in the case when the loan repayment would take place once – on the date of contract termination.
When deciding on an annual loan of PLN 1,200 with an interest rate of 10% and repayment at the end of the contract period, the APRC value will be the same as the nominal rate. Returning the loan in monthly installments, the APRC will increase to 10.47%, thus exceeding the nominal interest rate. The indicator assumes that a client who receives PLN 1,200 on a one-off basis, is able to multiply this amount more effectively than in the case when the payment was made in 100 PLN, monthly installments.
More expensive credit, lower APY?
The rule should be as follows: the lower the APY, the cheaper the loan. This is until we compare the loans taken out in the same repayment system. However, if we compare the costs of a regulated loan in equal installments and in decreasing installments, it will turn out that in the first case we will pay more interest, but the APR will be lower. In turn, by paying down decreasing installments, we will pay less for interest, while the APRC will be higher. It is clear from this that the lower APY is not always the same as a cheaper loan offer.
In summary, the actual annual interest rate allows you to quickly and easily compare the costs of individual loans and credits. However, it should be remembered that this is not a complete information and the lender may apply charges that do not affect the final level of this indicator. Therefore, the analysis of the APRC should be supplemented with the verification of the total cost of the loan.