Calculate the full cost of your loan using the Annual Percentage Rate (APR). This figure includes the interest you pay on the loan as well as the fees you incur over the years you are paying it off. The APR averages these figures over the life of the loan, so you can use the rate to compare different loans from different financial institutions and see which option is better for you. Compare the APR of a loan with its interest rate to identify excessive fees. Generally, you should choose the loan with the lowest rate; however, there are some exceptions to this.
1. Principal and Interest
To understand Annual Percentage Rate, you must first understand principal and interest. The principal is the amount of money you borrow for a loan. Interest is money on top of the loan amount, that you pay to the bank to compensate them for lending that money to you. Interest is a percentage of the loan amount, is a regular payment usually charged monthly or annually, and is paid for the duration of the loan. For example, on a loan of $200,000 with an interest rate of 5%, annual interest would be $10,000, possibly decreasing as the principal is paid down. The interest rate is often clearly listed on a loan product, and for most people, this informs their decision to borrow money. However, your decisions are better informed when you review the fine print before you borrow from a bank.