Why is knowing what APR is and how it works so important?
And how important is it?
Well, it is one of the Biggies when it comes to yours and your children’s’ financial health. In fact knowing what APR is is sooo important, that no parent should ever let a child leave home without fully understanding it. Here’s why…
We can probably all agree, we don’t like paying more than we should for something or wasting our money. But if you don’t know or fully understand APR, chances are that you have been and still are needlessly losing money every single month of your life. Why? Because…
APR is the Amount You Pay to Borrow Money
It is true that the majority of us need to borrow money (mortgage, cars, etc) at various stages throughout our lives. That’s normal. Understanding APR will stop us from paying too much for the money we borrow and allow us to get the Best Deals available – just savvy shopping really.
To get started, let me assure you that learning this stuff is really simple, and best of all, you can Immediately start to save money! (Common Sense APR Rules for Paying Off Your Debt – coming soon)
APR stands for Annual Percentage Rate. It is the amount of money (interest) that you have to pay over a year (365 days) on money you borrow from any person or institution – e.g. credit cards, store cards, bank loans, pay-day loan places, overdrafts, friends and family, etc. You will always find APR written as a %. So armed with this knowledge, here’s how it works…
If you borrow $1K at 10%APR, the cost to borrow that money is $100 per year to borrow. The longer that you take to pay back that $1K, the more it will cost you. For instance, if you do not pay back that $1K for 10 years, at the end of that 10 years, your cost is $1K to borrow $1K.
Why you may be Losing LOTS of Money
Every lending institution charges different rates of APR. So that means that you need to make sure any money you are borrowing has the lowest possible APR Deal you can get or you are losing money. Let me give you some real-life examples of APR deals you are likely to come across (remember we are keeping these examples simple):
- If you borrow $1K from your parents at 0% APR for 5 yrs, your loan will cost you $0
- If you borrow $1K from the bank at 3.5% APR for 5 yrs, your loan will cost you $175
- If you borrow $1K from a car dealership at 7.2% APR for 5 yrs, your loan will cost you $360
Now here’s where it really gets interesting!
- If you borrow $1K on a credit card at 18.9% APR for 5 yrs, your loan will cost you $945
- If you borrow $1K on another credit card at 27.3% APR for 5 yrs, your loan will cost you $1365
- If you borrow $1K on a store card at 39.9% APR for 5 yrs, your loan will cost you $1995
- If you borrow $1K from a short-term loan establishment at 495% APR for 5 yrs, your loan will cost you $24,750
- If you borrow $1K from a payday loan establishment at 999.9% APR for 5 yrs, your loan will cost you $49,995
The cost of each of the above loans are in addition to the $1K borrowed, which must be paid back too! As you can see, some deals are much better than others. (Find Out What Tricks Credit Cards Companies Use to Charge You Loads More Interest than you should be paying.)
How can some establishments get away with charging so much?
First, there is usually little-to-no regulation around the amount establishments charge for loaning people money. Banks do have more regulation restrictions and can’t generally charge as much interest for their loan ‘products’ as other establishments. Banks are usually a half a percent to a few percent above the country’s current national rate – the ‘base’ or lowest rate of interest that a country sets for its economy (this rate is flexible and will change over time). Other institutions set their own rates and have fewer or no regulations to adhere to. Additionally, EVERY institution charges higher APR rates to people with low credit ratings. This is because there is more of a risk that the institution will not get some or all of the money back that they’ve loaned out, so they charge the low-credit rated customer more to take that risk.
Do people really pay such high APR rates?
The sad answer to this is Yes, Yes, and YES. Lots of people do. I just came across a statistic that 1 out of 3 University students have taken out payday loans. 1 out of 3! (This is why no child should leave home without learning about APR – which most schools do not teach). That is a huge amount and still doesn’t account for everyone. On every ad that a lending institution runs, they are required to say or print their APR rates in it. The other day I saw a commercial, a very nice feel-good & we-are-so-here-to-help kinda ad, which had clearly printed in their footer an APR of over 1000%. The company was also reported in the news as making huge profits – no wonder considering the rates they are charging!
The reason why people take out loans with such high rates are:
- They don’t know what APR is or fully understand it.
- They are only interested in what their minimum repayments are going to be rather than what the loan will actually cost them. Some loans only require a minimum repayment which is less than the interest rate (APR), which means that the loan will never be repaid by only paying the minimum repayment amount; and the loan will get bigger as you’ll have to pay interest on interest as well. Ugh!
- They are only taking out a loan for a short time, so they don’t notice how high the APR really is. For instance – a $100 payday loan for 2 weeks at 899% APR means you’ll pay back your $100 plus an additional $34.48 at the end of the two week period. So for most people, that doesn’t seem like such a huge amount.
- They are desperate or their credit rating is so low or non-existent (How To Best Build Good Credit When You Have None) that they feel they have to resort to borrowing money from an establishment charging ridiculously high APR.
Lesson to Learn:
When borrowing ANY Money:
Get the Best Deal you can
On the lowest APR rate
Click for more on How To Do The Above and for The Best Plan To Get Out of Debt (coming soon), which can literally & immediately save you hundreds of $$$ a month and thousands more in the long run. And find out when debt becomes good and How Your Debt Can Actually Make You Money! (coming soon)
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