Another step you can take in making an informed decision on which loan or savings product you choose is to know as much as you can about the financial services you need so that you can shop around for the best deal.
Alongside it being your duty to do as much research as possible there is also a responsibility that the lenders have to you. The Consumer Credit Protection Act of 1968, also known as Truth in Lending, is a law requiring lenders to disclose all the costs affiliated with your loan. This is where the Annual Percentage Rate (APR) or the actual cost of the loan including fees and expenses is found. This rate is normally higher than any advertised rate that may have gotten your attention and should be the rate you use when deciding which loan will work best for your situation.
For example, the next time you receive a mailing for a credit card pay attention to the way the interest rate is advertised. The company may state that the interest rate is 10 percent however somewhere in the fine print will be a disclaimer indicating the APR is 10.25 percent. You must review the credit card company’s guidelines to be really sure about their offer.
Deception
There is a lot of confusion and complication when deciding to choose a loan based solely off of the APR. This is because lenders use APR’s differently. Some may include all of the fees associated with the loan while others will include some fees and leave others out. Lenders use this to get around the Truth in Lending law and provide the consumer with a number that will more likely get them to borrow.
Advantages of APY
Not only did the Truth in Lending law require lenders to provide the APR but it also requires them to quote interest rates on an annual basis. This is the Annual Percentage Yield. APY is easier to use over APR because it gives you numbers that you can compare. Whereas with the APR you couldn’t really compare numbers because all of the numbers were calculated differently depending on the lender.
With the APY it’s pretty simple. All you have to do is calculate the total interest earned on an interest-bearing account for a full year. The APY allows you to compare two products with the same length however one may pay interest quarterly while the other pays it monthly. Since it would be more complicated to compare the rates of the two products by using their methods of interest payouts, it would be easier to calculate the APY. The key thing to remember here is that some products you are calculating the APY for may not have a length of time for a year. They may only last for 6 months or so. In this case you would be using the APY to get an idea of which product is the best deal. Your calculations for that particular product will not give you the actual APY.
Clarity
APR, Annual Percentage Rate, is meant to be the cost of the loan in totality and is used when you are borrowing money. Meaning any fees or expenses normally are added in and the total amount you are going to pay for the loan is revealed in the APR. However, many lenders will only disclose certain fees and expenses in the APR making it a deceptive number. You should always read the fine print and if you have any misunderstanding contact a bank representative for clarity.
APY, Annual Percentage Yield is the total amount of interest you could earn on an investment or deposit product. It is used to calculate and compare your profit on different deposit products. It should be remembered here that if you are comparing products that don’t last as long as a year then you are only getting an idea of the potential earnings of those accounts for the sake of comparing and not getting the actual APY.
Another factor in calculating interest rates and their effects on your loan or investments is compounding interest. For more information on compounding interest you can take a look at the article “The Basics of Interest (Part Three)” where it is discussed in more detail.
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