The annual percentage rate (APR) is a Very Important Number.
If you are a borrower, it is the one number you should use when comparing loan offers.
If you are a lender in the United States, you must disclose the APR by providing potential borrowers with a Regulation Z APR Disclosure Statement in order not to run afoul of the law. (See who must prepare a disclosure statement below.)
This calculator will calculate the APR for any closed-end loan as well as create a compliant Truth-in-Lending Act disclosure statement.
This post discusses what the APR is and why you should use it and not the interest rates to compare loans. I'll also instruct users on how to create a disclosure statement.
Let's get started. More below...»
Again, I'll paraphrase from the CPFB:
A loan's interest rate is the cost you pay each year to borrow money expressed as a percentage. The interest rate does not include fees charged for the loan.
The annual percentage rate is the cost you pay each year to borrow money, including fees, expressed as a percentage. Therefore, the APR is (basically) the rate-of-return earned by the lender.
Yes! From the lender's perspective. Remember, the loan is the lender's investment and all investor's hope to make a return.
What's important for the borrower to remember, is the lower the APR, the less the loan will cost. Which makes sense. The lower the rate-of-return for the lender, the less profit they are earning on the loan they issue.
The APR was created by the TILA to give borrowers a way to compare loans.
Why can't I just compare the interest rate of two loans and select the loan with the lowest rate?
Good question, and here's why.
If you wanted to compare two loans using their quoted interest rates, you would have to know and understand a lot of details about how the interest rate is used to calculate each loan's interest.
For example, you would have to know:
Once you understand these details, then you would be able to calculate the interest due and compare the results.
Aside from fees, the APR isn't concerned with these details.
The APR calculation uses for input the anticipated total payment amounts. Periodic interest is never used in the equation.
Also, the TILA creates rules for how to calculate an APR. All disclosures have to use the same equations. This is not true for interest calculations.
This is why the APR is a Very Important Number.
But the APR is not the only thing that Regulation Z requires the lender to disclose.
The federal Truth-in-Lending Act requires that borrowers receive written disclosures about important terms of credit before they are legally bound to pay the loan.
In addition to the APR, the following must be prominently shown:
Finance Charge: cost of credit expressed as a dollar amount (this is the total amount of interest and certain fees you will pay over the life of the loan if you make every payment when due);
Amount Financed: the dollar amount of credit provided to you;
Total of Payments: the sum of all the payments that you will have made at the end of the loan (this includes repayment of the principal amount of the loan plus all of the finance charges)
The TILA disclosure will also include other important terms of the loan such as the number of payments, the monthly payment, late fees, whether you can prepay your loan without a penalty, and other important conditions. Exactly what must be included on the disclosure statement varies depending on the conditions of the loan itself.
The disclosure statement that this calculator creates is fully compliant with the TILA.
Alright, we've defined "APR" and we've covered at a high level what loan terms must be disclosed, but how do I use the calculator?
That question is answered in the next section.
The annual percentage rate calculation, as Regulation Z documents it in Appendix J, does not care about pesky details.
The calculation does not need to know what the loan's compounding frequency is. It does not care if the loan uses 360 or 365 day years. It does not care if the interest is calculated using same day months or calculated using the exact number of days in a month.
What the calculation requires is the following:
Using these details, the calculator will calculate the four values lenders must reveal.
The amount financed is calculated by determining the principal loan amount and adding any other amounts that are financed by the creditor and are not part of the finance charge, and subtracting any prepaid finance charges such as prepaid interest and loan application fees.
The finance charge is the cost of consumer credit as a dollar amount. It includes any charge payable directly or indirectly by the consumer and imposed directly or indirectly by the creditor as an incident to or a condition of the extension of credit. Note, however, finance charges do not include any charge of a type payable in a comparable cash transaction.
Finance charges include but are not limited to the following (as quoted from 226.4 of Reg. Z):
A special note about prepaid interest. Loans can and will close on any day of the month, not just on a payment due date. If payments are due on the first and a loan closes (loan amount is made available) on the twenty-sixth, the first payment frequently will not be due until the first of the 2nd month following the closing. That is, if the loan closes on July 26 the first payment will be due on September 1st. The time between the loan closing and the first payment is longer than a month. This is called a long initial period. The lender is going to want the interest they are entitled to for these 6 days (July 26 - August 1). They can collect the interest for the 6 days by adding it to the September 1 payment. Or, they can ask for the interest on the day the loan closes. If they collect it on the day the loan closes, this is prepaid interest.
You can use this interest calculator to calculate exact day prepaid interest.
But here's a tip. When it's all said and done, an APR disclosure statement is almost always just an estimate since it has to be given to the borrower even prior to the loan closing. Frequently the closing date isn't even known when the disclosure is provided. Therefore, keep it simple, and just assume regular length periods!
But with that said...
If the software used to calculate the APR is not accurate, the lender may be subject to fines and adverse publicity leading to reputational damage.
The next section will prove to you the accuracy of this calculator.
Lenders and borrowers need to have confidence in the tools they use.
Is there any better way to prove the accuracy and flexibility of this calculator than to give the user the ability to quickly load each of the 20 calculations from Regulation Z, Appendix J, and allow them to calculate the results?
Of course not.
And that's just what this page does.
Click on the links below to preload the calculator with the inputs specified by the particular example. You can then click on "Calc" and compare the result with the result defined in the regulation.
Skeptical? Change one of the inputs and recalculate. You'll see the APR result change.
Not only does this confirm the accuracy of this calculator, but it also shows its flexibility. It handles even the closed-end loan examples with multiple loan advances such as construction loans and student loans. (I have not found another calculator on the web that can do these calculations.)
Go ahead, try a few examples. Remember, just click on a link and the details will be preloaded for you in the calculator. No need for manual entry!
Regulation Z classifies the following five examples as "(1) Single advance transaction, with or without an odd first period, and otherwise regular."
Regulation Z classifies the following two examples as "(2) Single advance transaction, with an odd first payment, with or without and odd first period, and otherwise regular."
Regulation Z classifies the following two examples as "(3) Single advance transaction, with an odd final payment, with or without an odd first period, and otherwise regular."
Regulation Z classifies the following two examples as "(4) Single advance transaction, with an odd first payment, odd final payment, with or without an odd first period, and otherwise regular."
Regulation Z classifies the following four examples as "(5) Single advance, single payment transaction."
Regulation Z classifies the following three examples as "(6) Complex single advance transaction."
Regulation Z classifies the following two examples as "(7) Multiple advance transactions."
A lender, whether that lender is a business or an individual must comply with the Truth-in-Lending-Act and provide the borrower with a disclosure statement prior to offering or extending credit when four conditions are met:
As you can see, there is a lot to understanding the Truth-In-Lending Act and an APR Disclosure Statement.
However, if you are a borrower, and you are comparing loan options, just compare the APRs. And assuming the lenders are of similar quality and offer the same or similar services, go with the loan that has the lower APR.