Why Understanding APR is Important to Your Finances

interest-aprFor most of us, we look at the APR, or Annual Percentage Rate, of our loans and other financial obligations and usually don’t see much difference in them over the actual interest rate. In fact, it’s all too easy for someone to just casually compare the two and figure that they are paying more or less the same. However, this is not true. Failing to consider the APR, especially in a variable interest rate loan, is something that will cause you to slowly lose money over time, because you’ll be paying extra interest.

That’s because where an interest rate is the exact figure you’re going to be charged for interest, the APR is a look at the bigger picture, and accounts for other costs that may be associated with a loan and calculated as a part of your total repayment obligation. In the case of a large credit, such as a mortgage, it can make a big difference over the life of your purchase – even though you might not notice it as much when casually looking over the figures. Some examples of the charges you might see are application fees, or processing fees. In simple terms, it’s any added cost to your loan that needs to be paid in order to receive the loan.

Put another way, it represents money you never received, but still ended up borrowing. For example, a £200,000 loan, with added costs of £5,000, and an interest rate of 7.5pc over 30 years will actually have an APR of 7.7542pc. While that may not seem like much, it’s actually more than enough to buy a new car, if you’re considering a larger loan, such as a mortgage. Use an APR calculator yourself, or have a look at the calculations below to see what we mean. Flat 7.5pc Interest Rate Over 360 Months:

  • £200,000.00 Total Loan Value
  • £5,000.00 Extra Costs (money you borrowed but never received)
  • £1,398.43 Monthly Payment
  • £303,434.45 Finance Charges
  • £503,434.45 Total Payments

Effective APR of 7.7542pc Over 360 Months:

  • £200,000.00 Total Loan Value
  • £5,000.00 Extra Costs (money you borrowed but never received)
  • £1,433.39 Monthly Payment
  • £316,020.31 Finance Charges
  • £516,020.31 Total Payments

That’s a whopping £12,585.86 in extra costs. While one could easily look at that number and write it off as something relatively insignificant in terms of the total loan value, it’s not. That’s £34.96 per month more you’ll be paying, which works out to £419.52 per year. Considering that some people in the UK can feed a family of three on about £1,300 per year, that represents almost four months of your yearly shop. It’s also enough to buy a new phone every year, or any number of other things you might want to that you would normally consider frivolous binge purchases.

This can be a big factor in calculating loans you decide to accept, as a fixed rate loan will always have the same costs associated, due to the total interest not changing up or down. For variable interest rates, obviously a downward change would be in your favour, but an upward trend would not. Again, taking the above calculations, let’s say your base interest rate changed up from 7.5pc to 8.0pc. Your new monthly payment would end up being £1,504.22. That’s £105.79 more you’d be paying each month, which adds up to £1,269.48 per year. You would be spending almost enough extra to make another loan payment every year, and pay a 30-year mortgage off more than two years early.

Obviously a lot goes into considering any loan, but not being aware of what the APR is can significantly change your initial financial calculations and planned repayments for the worse. Over time, these little changes can add up into something much larger than you had considered. That’s a big change that can make problems later – especially if you are using a variable interest rate loan. Remember, any upward change in your rates can rapidly increase monthly payments. This will quickly push you out of your planned budget thresholds and into the red.

To protect yourself against this, make sure you follow these steps:

1) Always calculate the complete APR. If you are working from a variable interest rate, then calculate a worst-case scenario and make sure you’ll be able to afford it. If you fail to account for certain charges, writing them off as either too small to worry about, or insignificant in comparison to your overall loan, you’re not only wasting money, but can also find yourself in a bad position if the financial market changes for the worse.

2) Plan in advance for financial changes that might cause you to be worse off. While you will need to account for possible changes in employment, there is more to it than that. You’ll also want to consider what happens if the market changes drastically and your variable interest rate hits the cap. Should this happen, it’s unlikely other lenders will have better rates. Then you’ll be stuck with no options. Make sure you can afford your payments if this happens.

3) Do your homework on any loan before taking out. Not all loans are equal, and some loans that offer better interest rates up front may have significantly higher fees, which will cause the APR (what you’re really paying) to be much higher than a loan with a larger interest rate, but lower APR. This should be a determining factor in the loan you ultimately accept and is something you should discuss with your lender before signing any loan agreement.

Remember to shop smart, and look for the best deals. Money saved is money you can invest, while a higher APR is just wasted money if it can be avoided. Always make sure you understand exactly what you are getting into, and what you’ll be paying. Doing that up front can save you from some of the more common loan and mortgage pitfalls.

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image credit: 401(k) 2012

The Next Chapter…

As you may have noticed, Money Spruce hasn’t seen many updates lately. After quitting my job in May 2012 and becoming a full-time freelancer, there’s just been less and less time to write on here.

Today, I’m announcing the launch of my new business: Content Strategy for Do-Gooders.

CWAM is a one-stop shop for content strategy and creation for social mission-driven businesses and organizations. CWAM’s focus is to help these businesses amplify their social impact using effective content to tell their story, find more followers, and develop a loyal tribe of supporters.

Why am I making this change? There …

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Updated: How I Used Free Frequent Flyer Miles to Get $9,000 Worth of Airfare — Twice!

Update: I just booked another trip using frequent flyer miles. This time I’ll be flying to Japan, India, and Nepal — for just $120! The real cost was just 80,000 miles that I earned from a couple of credit card offers.

For those who missed it last year, here’s my strategy that I posted in October 2012. Enjoy!

I’m excited to share how I’m spending a month traveling to Paris and Bangkok – and spending only $140 on airfare (just the taxes). How? It was really easy, actually: Free frequent flyer miles.

No, not the kind you earn from flying …

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Beyond Money: How to Find Happiness in Your 20s (or Any Time)

find-happiness-Thailand

find-happiness-ThailandI spend a lot of time thinking about how to be happy, and I think I’ve finally cracked that code.

Sometimes I even spend more time thinking about how to be happy than anything else, including my business. Why? Because that’s what matters most. We don’t really want to just have more money, more friends, or more freedom — we just want each of these things to make us happy.

Whether you’re struggling with money, a job, or just surviving daily life, here’s my best advice for being happy no matter what.

Don’t wait – choose to be

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Why I’m Writing One Letter A Day to Thank 365 People

Screen Shot 2012-11-05 at 9.42.37 PM

Today, I’d like to announce a new project that I’ve been working on and keeping a secret for over a month now. It’s called “365 Letters of Gratitude.”

The concept is simple: every day, I spend a few minutes writing a letter to a different person whom I’m grateful to have in my life. Usually it’s just a few paragraphs detailing why these people mean so much to me and the ways they’ve affected my life, large or small.

It’s been hard, but I’ve kept it going for 45 days now. And I’m so grateful that I’ve done …

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How You’re Lying to Yourself Every Day About Your Spending Priorities

liar

I’ve heard a few great arguments made lately about how we make liars out of ourselves all the time with our so-called “priorities.” Many of us say “Travel is DEFINITELY a priority for me” or “I’m serious about getting in shape.” But are these things really priorities? And does the time and money you spend on these things really back up what you’re saying.

JD Roth of Get Rich Slowly first brought this to my attention at the World Domination Summit 2012 when he said “It’s not what we say is a priority, but what we actually DO that’s a …

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Thinking of Quitting? Self-Employed Lessons, 2 Months Deep

oregon-welcome

That first two months after (finally) quitting my job definitely flew by! I’ve had a successful move from New Haven, CT to Portland, OR! Life has been memorable in a gazillion ways, and the fun is just getting started.

Today I bring to you lessons I’ve already learned and that you’ll need to watch out for or can look forward to for yourself.

Self-Employed = Awesome!

So far, 99% of the time has been freakin’ fantastic. You’re probably thinking I’m exaggerating, but I can honestly say I couldn’t be happier with life right now, and I’m committed to doing every …

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I Did It! I QUIT My JOB!

yup-i-freakin-quit

This is the post of I’ve been waiting to write and, after 9 months in the making, it’s now official: I quit my job! It feels like a huge relief to finally be done and to move on from New Haven, too.

Why I Quit

There are a few reasons I decided to leave my job:

1) I was bored and unhappy. While my job wasn’t stressful and my boss was great, I was bored at my job. I felt like I wasn’t going anywhere and wasn’t making a difference in the world on a daily basis. I’m sure …

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Life After Quitting – A Few Quick Updates

I know it’s been a few weeks since I’ve given any updates, but I’m working on a big post about quitting my job (which I did 2 weeks ago). Look for it soon.

In the meantime, I’ve also been writing weekly for Hat Toss, a site with money, career, and health tips for college students and grads. Here are a few of my recent posts up there. I’d love it if you’d stop by and Like or Tweet the posts:

Your First Paycheck! What to Do Before Spending It – Just as it sounds, this post has advice …

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Travel When Retired? No! Travel Now!

travel-young

I just don’t buy into the whole “travel when you’re retired” thing. It seems like such a waste to wait my whole life to travel (and, not to be morbid, but assuming I make it to retirement age).

I just got back from my latest trip to Montreal, which was fantastic. It was my first visit, and it definitely won’t be my last.

Despite the cost $400 and the fact that I’ll soon be jobless, I took the trip on my own for a few reasons:

1) I really wanted a getaway from New Haven and

2) I wanted …

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