Banks and other lenders are required to disclose a rate called the APR. a. What is...

Banks and other lenders are required to disclose a rate called the APR.

a. What is this rate?
b. Why did Congress require that it be disclosed?
c. Is it the same as the effective annual rate?
d. If you were comparing loans could you use their APRs to determine the loan with the lowest effective interest rate?

Solutions

Expert Solution

Annual Percentage Rate (APR) is the cost of borrowing per year or income earned from an investment per year, expressed as percentage of Principal. This includes mainly interest, and fees or other charges if any applicable per year.
Truth in Lending Act (TILA) mandates that each lender should disclose the actual cost of borrowing to the prospective borrowers so that the they can take informed decision. For this purpose, the APR which is the total cost of loan should be informed to the customers. This is to protect the customers from unfair practices and hidden charges. The customers can compare APRs of various lenders and choose from among them, according to their preference.
Effective Annual Rate(EAR) is the simple rate of interest representing the actual amount of return during the period. To make it simple, it is the total amount of interest on a deposit or loan, applicable for the period of one year, as a percentage of principal. The amount of interest taken for this purpose could contain compounding effect within the period, but the same is converted into the form of rate in the Effective Annual Rate.

APR may contain fees and other charges along with interest and is the rate quoted, to be applied with or without compounding at the desired/ stated frequency. On the other hand, EAR is the statement of cost as a rate, including the effect of compounding, if any.

While comparing loans, APRs can be used to evaluate the cost involved, including the effective interest rate.

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