When it comes to credit cards, there are a lot of acronyms and terms that can be confusing. Two of the most commonly misunderstood terms are APR and EAR. APR stands for annual percentage rate, while EAR stands for effective annual percentage rate. They both relate to the cost of borrowing money, but they measure different things. In this blog post, we will explain the difference between APR and EAR, and help you figure out which one is more important to you.
What is APR?
APR, or annual percentage rate, is a measure of the cost of borrowing money. APR includes both the interest rate and any fees charged by the lender. The APR is calculated by taking the interest rate and adding any upfront costs, such as points or origination fees. APR is typically higher than the interest rate because it includes these additional costs. APR is generally expressed as a percentage and is used to compare different loans. When shopping for a loan, it’s important to compare APRs to get an accurate picture of the total cost of borrowing. Loans with lower APRs will typically have lower overall costs, making them more affordable in the long run.
What is EAR?
The EAR, or effective annual rate, is the true yearly cost of borrowing money. It takes into account the fact that compounding occurs throughout the year, not just once at the end. In order to calculate the EAR, you first need to determine the periodic interest rate. This is simply the stated annual percentage rate divided by the number of periods in a year. For example, if you’re borrowing money at a 5% APR for a one-year loan, your periodic interest rate would be 0.05/12, or 0.004167%. Once you have determined the periodic interest rate, you can calculate the EAR using the following formula: EAR = (1 + i/n)^n – 1. In this formula, “i” represents the periodic interest rate, and “n” represents the number of compounding periods per year. Plugging our example values into this formula, we get an EAR of 5.038%. This means that even though the stated APR is only 5%, the true cost of borrowing money is actually 5.038%.
Difference between APR and EAR
APR, or annual percentage rate, is the interest rate charged on a loan, expressed as a percentage of the loan amount. APR includes not only the interest rate but also any other fees that may be charged, such as points or closing costs. EAR, or effective annual rate, is the total cost of borrowing, taking into account all fees and compounding the interest. In general, APR is lower than EAR because APR does not take into account the effect of compounding. However, both APR and EAR can be useful when comparing loans. APR can give you a sense of the true cost of the loan, while EAR can help you compare loans with different compounding frequencies.
Conclusion
The difference between APR and EAR can be confusing for consumers. However, it is important to understand the difference when shopping for a loan or credit card. By understanding how these two rates are calculated, you can make more informed decisions about your finances.
