Annual Percentage Rate - Multiple Definitions of Effective APR

Multiple Definitions of Effective APR

There are at least three ways of computing effective annual percentage rate:

• by compounding the interest rate for each year, without considering fees;
• origination fees are added to the balance due, and the total amount is treated as the basis for computing compound interest;
• the origination fees are amortized as a short-term loan. This loan is due in the first payment(s), and the unpaid balance is amortized as a second long-term loan. The extra first payment(s) is dedicated to primarily paying origination fees and interest charges on that portion.

For example, consider a $100 loan which must be repaid after one month, plus 5%, plus a $10 fee. If the fee is neglected, this loan has a (year-long) effective APR of approximately 80% . If the $10 fee were considered, the monthly interest increases by 10% ($10/$100), and the effective APR becomes approximately 435% (, as 535%-100%=435%). Hence there are at least two possible "effective APRs": 79% and 435%. Laws vary as to whether fees must be included in APR calculations.