Are you searching for a personal loan and getting confused about the terms? You’re not alone! Each lender has their own way of explaining the terms and conditions. Sometimes, this can result in a difficult time for the customer in understanding what they’re really getting.
In this article, we’ll talk about 2 commonly seen terms: interest rate and APR, or Annual Percentage Rate. You’ll need to understand both these terms when it comes to taking out a loan. With a better understanding, you’ll be able to determine which product or service is the most beneficial for you.
Interest Rate is the percentage charged by lenders for the use of their money over a certain time period. In the vast majority of cases, lenders will announce the annual interest rate, which means the total interest over one year. For example, if you borrow $1,000, and the interest rate is 10% over a one-year period, you’ll need to repay $1,100 by the end of that year.
You might ask, how do lenders determine the interest rate? There are many criteria considered. You may notice that often times different people will qualify for different interest rates. This is because when setting the rate, lenders calculate the risk they need to take on when lending out this money. They’ll take into account many factors, such as the borrower’s credit score, income, and assets. They might even look at the purpose for which you’re borrowing the money! If you want to buy a home, for example, the interest rate could be much lower than if you wanted to take out a personal loan to buy a sail boat.
There are many institutions which deal with loans, and banks are by far the most well known. They are the largest and most popular institutions, and also have the most money to lend out. However, due to this, banks are able to pick and choose to whom they would like to lend money. Most of the times, banks will generally choose to lend to people with better qualifications in terms of credit score, income, or assets. If someone is lacking in any of those categories, they might have a difficult time getting a bank loan.
Luckily, for those who have been turned down by a bank, there are many private lenders who are more willing to lend money than the banks. However, the interest rates will most often be higher due to the higher risk they are taking on.
APR, or Annual Percentage Rate is also expressed as a percentage but is often higher than the interest rate. Do you know why? It’s because the APR is the annual cost of the loan for the borrower, and it may include many other expenses which the lender may choose to “roll into” one single rate.
Let’s say that you need to borrow $1,000 and will repay it in one year. The lender charges 15% interest rate and 24% APR. Based on the interest rate, the amount you should repay is $1,150. In reality, however, the total cost of the loan will be $1,240. The $90 difference is from the fees charged by the lender to approve and fund your loan.
A key takeaway is that when you’re searching for a lender, and you see both interest rate and APR, the APR is true cost of borrowing. Apply your due diligence and make sure you know how much per month you’re paying, and how much the total cost of borrowing will be.
No one wants to pay more for the same service, right? Lenders are financial service providers, and there are many competitors in the market waiting for clients. It’s up to you to consider all the options and make the best decision. No one cares more about your money than you do, so go out there and be your own best advocate!
FlexFi Inc. is not a financial advisory firm.
This article is for informational purposes only and is not a substitute for individualized professional advice.
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