What is the APR and the real costs of loans

It is important to know what the APR is, also known as Annual Percentage Rate, and how it indicates the total costs of a loan, calculated over the year. It is therefore the most important value for comparing different credit offers, since this percentage includes all the costs associated with the loan.

Table of contents

1. Understanding the concept

2. Types of loans

3. Influence of TAE

4. Practical example

5. Summary table

We have all at one time or another resorted to applying for credit, so learning to analyze this indicator correctly can change our financial mindset. can change our financial mindset. To understand what APR is, it is necessary to understand the different types of credit on the market, and how this rate influences them.

Understanding the concept of what the APR is

Let's go to the practical aspect to understand what the APR is and how we can calculate it. Imagine you want to apply for a loan, and you have a choice between two offers. Of course, you want to compare them to each other to find out which loan will allow you to which loan will allow you to improve your financial situation. The pure interest rate of the loan (NIR), plus the additional costs of the loan, such as fees, residual debt insurance and other account management fees make up what is the APR as a concept. And therein lies the answer to your decision questions.

Now that we know what the APR is, let's see how it can be how this rate can be calculated. While it is possible to perform the calculations in many different ways, in any of the cases it is necessary to know the costs of the loan and the net loan amounts to obtain the actual interest rate.

One of the most common methods for calculating the APR

APR = (cost of credit ÷ net loan amount) × [24 ÷ (term in months + 1)] x 100

To illustrate this abstract formula that aims to calculate what the APR is, let's assume that you want to borrow 30,000 euros and pay it back in installments over 48 months. There are currently two offers available to you, so you would have to perform the following calculations:

Loans should always be requested with a prior calculation of terms and interest to be paid on them.

Offer 1:

Includes residual debt insurance and an additional processing fee of 3,000 euros.

APR = (3,000 ÷ 30,000) × [24 ÷ (48 + 1)] x 100 = 4.89%

Offer 2:

It only includes residual debt insurance of 2,000 euros.

APR = (2,000 ÷ 30,000) × [24 ÷ (48 + 1)] x 100 = 3.26%

Knowing what the APR is, we can compare the interest rates of the two loan offers using the percentage value. And we will find that offer two is the cheapest.

Types of loans 

Both individual loans and consumer loans are financial products offered by lending institutions to individuals. Although the two terms are often used interchangeably, there are some subtle differences depending on the context or the financial institution offering them.

• Individual loans. These are credit products intended for personal, commercial or educational purposes, among others. Their use can be very varied, from the purchase of consumer goods to investment in a personal business or payment of studies. Depending on the lender, these loans may have more flexible terms in terms of amounts, interest rates and repayment terms.

• Consumer loans. These are a subset of individual loans specifically designed for the purchase of consumer goods and services. This includes such things as appliances, vehicles, travel, and more. They are intended solely for personal consumption and should not be used for investments or business expenses. They usually have shorter repayment terms and more limited amounts compared to other types of individual loans. Interest rates can vary widely depending on the perceived risk and creditworthiness of the applicant.

These types of individual or consumer loans also differ from other types of credit, such as mortgages or business loans. They are conceived for specific purposesand with collateral that is usually the mortgaged property the mortgaged property itselfor the assets of the company.

Influence of TAE 

Loans may have several costs associated with them that affect the total amount to be paid by the borrower. These costs vary vary depending on the type of loan, the lenderthe lender and the specific terms of the loan agreement.

The multiple loan modalities have made possible the existence of an infinite number of possibilities when it comes to assessing the application for money.

Some common examples of costs associated with a loan are interest, origination and origination fees. Although there may be other charges, such as insurance or fees for study, cancellation or early repayment. In the case of some loans, such as mortgages, there are also costs for the loan deed and the registration of the mortgage in the Land Registry.

Practical example. What is APR and how to select the best loan

General parameters:

• Loan amount: 10,000 euros

• Loan term: 5 years (60 months)

Scenario 1: Loan with a lower Nominal Interest Rate

• Nominal Interest Rate (NIR): 5%.

• Annual Percentage Rate (APR): It will be calculated based on the NIR and additional commissions (we will assume an opening commission of 1%).

Scenario 2: Loan with a Higher Nominal Interest Rate

• Nominal Interest Rate (NIR): 7%.

• Annual Percentage Rate (APR): It will be calculated based on the NIR and additional commissions (we will assume an opening commission of 1%).

We calculate the monthly payment for each loan using the French amortization system, which is the most common in Spain, and we will also adjust the APR to include the origination fee.

Scenario 1:

• Monthly fee: Approximately €188.71.

• Adjusted Annual Percentage Rate (APR): 5.2% (this includes the effect of the origination fee spread over the term of the loan).

Scenario 2:

• Monthly fee: Approximately €198.01.

• Adjusted Annual Percentage Rate (APR): 7.2% (this also includes the effect of the origination fee on a simplified basis).

With these cases it is clear that knowing the concept of what APR is allows us to compare effectively the total cost of different loans. Even if they have different fee structures.

Summary table

Understanding the concept	What is the APR (Annual Percentage Rate)? How this concept is calculated.
Types of loans	Analysis of the difference between individual and consumer loans. Difference with respect to mortgages or business loans.
Influence of TAE	Examples of costs associated with a loan. Frequency of APR installments on loans in Spain. What are the fees charged by the bank in case of a loan?
Practical example	Real cases of loans in Spain with different interest rates and APRs. How to properly select the loan based on knowledge of the APR.

If you are interested in learning more about any of these issues in order to improve your performance in your university career in IE UniversityICADE, ICADE, CUNEF, Columbia or any other, or to take part in one of our Executive courses for companiesyou can send us a message.