What Does the APR (Annual Percentage Rate) Really Mean?

31 Mar What Does the APR (Annual Percentage Rate) Really Mean?

Recently, several members of the Bankruptcy Law Network were having a discussion about a payday loan. The payday loan company would loan someone $100, and they would have to pay $115.00 back two weeks later. What is the interest rate? (No, this isn’t a word problem on a math test!)

The payday loan company said that the interest rate is 15%, since 15% of the loan is being repaid as interest. While accurate from one perspective, this number is very misleading.

The interest rate on nearly all loans is determined on an Annual Percentage Rate, or APR. This means that you look at the interest that would be paid on the loan in a year, divide it by the principal balance, and come up with the APR. For example, if you borrow $100 on January 1 and pay $1 per month in interest for 12 months, the loan has a 12% APR, since 12÷100 = 0.12 = 12%.

This works for larger loans as well. If you pay $500 per month interest on a $100,000 loan, the APR is computed this way:

$500 x 12 months = $6,000.
$6,000÷$100,000 = 0.06 = 6%

So if you’re paying $500 per month interest on a $100,000 loan, the APR is 6%.

Let’s look at that payday loan again…

$15.00 interest for 2 weeks = $390 per year.
$390÷$100 = 3.90 = 390% APR

So that loan that requires you to pay “only” $115 back in two weeks really has a 390% APR!

In my day, they used to call that “usury” to be nice but what it really is is “loan sharking.” It used to be illegal. Now I guess it’s just considered good business.

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Brett Weiss, a senior partner at Chung & Press, LLC, represents people and businesses in all phases of bankruptcy. He has experience in complex individual Chapter 7, Chapter 11 and Chapter 13 bankruptcy cases, and in Chapter 11 small business restructuring and reorganization. Mr. Weiss lectures nationally on bankruptcy issues. He has testified before the Federal Bankruptcy Rules Committee, the Consumer Financial Protection Bureau, and has twice testified before Congress on bankruptcy and credit issues. Brett Weiss is the co-author of Chapter 11 for Individual Debtors, and has written Not Dead Yet: Bankruptcy After BAPCPA, for the Maryland Bar Journal, as well as hundreds of blogs for the Bankruptcy Law Network. With his law partner, he recorded a 13-hour basic bankruptcy training series, and leads intensive three-day Chapter 11 training boot camps. Mr. Weiss has received international media attention in connection with his work. He was interviewed by Barbara Walters on The View, has appeared on the Today Show, Good Morning America, ABC News with Peter Jennings, the Montel Williams Show, National Public Radio, AARP-TV, the BBC World Service, German state television, and numerous local radio and television programs, and been quoted in Money magazine, The Washington Post and The Baltimore Sun, among others. Brett Weiss is the Maryland State Chair for the National Association of Consumer Bankruptcy Attorneys, a founding member of the Bankruptcy Law Network, on the board of the Maryland State Bar Consumer Bankruptcy Council, and a member of the American Bankruptcy Institute, the Bankruptcy Bar Association of Maryland, and the Civil Justice Network. He has been recognized as a “Super Lawyer” every year since 2007 for Maryland and the District of Columbia, and in 2011 received the Distinguished Service Award from the National Association of Consumer Bankruptcy Attorneys for his work on behalf of consumers across the country. Mr. Weiss is admitted to practice before Maryland and District of Columbia federal and state courts, the United States Courts of Appeals for the DC, Fourth and Eighth Circuits, The United States Tax Court, and the Supreme Court of the United States, and has been practicing law since 1983.
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