A:

The annual percentage rate of a loan is the measurement of how expensive it is to borrow money over the course of one year. There are several other measurements of borrowing expense – the effective annual rate, the annual equivalent rate and the annual percentage yield, among others. APR is considered to be one of the most important, because it includes fees and other expenses associated with lending agreements, not just interest rates.

There are differences in how APR is calculated based on the regulations that govern the lending institution. In the United States, the calculation and subsequent disclosure of any APR is governed by the Truth in Lending Act (TILA). The European Union regulates APR through two directives, 2008/48/EC and 2011/90/EU, but significant uniformity between member nations was not really instituted until 2013.

APR in the U.S.

For American lenders, APR is specified to mean the nominal interest rate adjusted to include certain non-interest costs. The types of costs that can be charged are not specifically regulated by TILA, but the requisite disclosures are. By law, credit issuers must clearly display the APR to their customers. Credit card companies are allowed to display monthly interest rates instead of annual interest rates, but no agreement may be signed without some disclosure of the annual rate.

Mortgages have their own APR disclosure requirements in the U.S. Under the Mortgage Disclosure Improvement Act of 2008, final APR cannot vary more than 0.125% from the good faith estimate, or else the transaction must be delayed and a new APR disclosure is required.

APR in Europe

European laws also highly emphasize disclosures with regard to APR. There is a specific algorithm used in E.U. APR calculations that presumes a 365-day year with 12 equal months. These calculations do not apply to every loan, however. Any loans in excess of €50,000 (as of 2014) do not have to use the standard algorithm, and no mortgages are required to use it.

Directive 2008/48/EC is also known as the Consumer Credit Directive in the E.U. This directive establishes the Standard European Consumer Credit Information, which is a series of disclosures that have to be provided to customers before the lending contract is signed. Directive 2011/90/EU is an amendment to prior APR calculations, and it provides different assumptions that must be applied by any simulated APR figures.

The United Kingdom is not a full member of the EU, and it does not have to comply with all E.U. directives. The U.K. Consumer Credit Act of 1974 regulates the use of APR by British lenders, and it requires that APR be published in a prominent and visible way for any loan. All regulations on lending rates and disclosures are overseen by the Financial Conduct Authority.

All of these rates are nominal. Lenders do not typically build in assumptions to account for the effect of inflation on borrowing power and borrowing costs.

RELATED FAQS
  1. What is the difference between an interest rate and an annual percentage rate (APR)?

    Comparing the annual percentage rate (APR) on competing loans help you understand the true cost of the loans and make a wise ... Read Answer >>
  2. Do lenders offer floating APRs?

    Learn about credit cards with floating, variable and fixed APRs. Explore introductory rates offered by two leading credit ... Read Answer >>
  3. What is the difference between APR and APY?

    Learn about the difference between the calculations for APR and APY. APY takes into account the number of times that the ... Read Answer >>
  4. Are balance transfers worth it?

    Balance transfers on credit cards are often a way to save a lot of money over the short and medium term. Read Answer >>
Related Articles
  1. Investing

    The Interest Rates: APR, APY And EAR

    When most people shop for financial products, all they focus on is the listed interest rate. Human eyes instinctively dismiss the fine print, which usually includes the terms APR (annual percentage ...
  2. Personal Finance

    APR and APY: Why Your Bank Hopes You Can't Tell The Difference

    Banks use these rates to entice borrowers and investors. Find out what you're really getting.
  3. Small Business

    Swift Capital Review: Safe for a Business to Use?

    In this Swift Capital review, find out how these short-term operating loans work for small businesses – and whether they're a good deal.
  4. Personal Finance

    States That Allow Car Title Loans

    Only some states permit car title loans – and those that do may have restrictions. Check this list to see what to expect.
  5. Tech

    Good Credit? Try This Credit Card Alternative

    Personal loans are a credit card alternative to try if you've got great credit and you want to lock in a lower interest rate on what you borrow. [underlined word is credit card alternative]
  6. Personal Finance

    7 Factors For Comparing Credit Cards

    It's good to find a credit card that fits your lifestyle, but read the fine print to make sure you're not overpaying for the benefits.
  7. Investing

    APR vs. APY

    Annual percentage rate and annual percentage yield are two ways companies calculate the amount of interest you can owe. Learn more about them and find out which is the better rate.
  8. Personal Finance

    Personal Loans: Consider These Alternative Lenders

    Looking for an alternative source of financing for a personal loan? Take a look at these companies.
  9. Personal Finance

    Understanding Home-Equity Loan Rates

    Shopping is the most important part of getting a home-equity loan. You're going to have to live with the terms for a long time.
RELATED TERMS
  1. Annual Percentage Rate - APR

    The annual rate that is charged for borrowing (or made by investing), ...
  2. Purchase APR

    The annual percentage rate that applies to outstanding balances ...
  3. Behavior-Based Repricing

    The changing of a credit card holder’s interest rate based on ...
  4. Truth In Lending Act - TILA

    A federal law enacted in 1968 with the intention of protecting ...
  5. Amount Financed

    The actual amount of credit made available to a borrower in a ...
  6. Disclosure

    The act of releasing all relevant information pertaining to a ...
Hot Definitions
  1. SEC Form 13F

    A filing with the Securities and Exchange Commission (SEC), also known as the Information Required of Institutional Investment ...
  2. Quantitative Easing

    An unconventional monetary policy in which a central bank purchases private sector financial assets in order to lower interest ...
  3. Risk Averse

    A description of an investor who, when faced with two investments with a similar expected return (but different risks), will ...
  4. Indirect Tax

    A tax that increases the price of a good so that consumers are actually paying the tax by paying more for the products. An ...
  5. Zero-Sum Game

    A situation in which one person’s gain is equivalent to another’s loss, so that the net change in wealth or benefit is zero. ...
  6. Beta

    Beta is a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole. ...
Trading Center