Question

Should we care more about APR or EAR? Why?

Answer 1

ANSWER

APR (Annual percentage rate) and EAR (Effective annual percentage rate) are used for determining annualised income from investments or cost of the loan.In terms of simplicity, APR is the simple way of calculating interest per year. Simply speaking, APR is Simple interest rate per year and EAR is Compounded interest rate per year. Although both are important, EAR will be more useful as it will provide us with true cost or rate of return after compounding interest over the time.On the other hand, APR does not include compounding effects. Further, EAR also includes additional costs over the year. EAR will be more useful for evaluating compounding loans. In the investing. EAR is important where investments in which interest cannot be withdrawn midway through the term of the loan.

In case where loans carry high closing costs and/or annual fees, such as mortgage loans,  EAR will be much more useful in budgeting for the cost of borrowing the money.

Any APR can be converted to an EAR using the rate per compounding period and the number of compounding periods in a year. EAR= ((1 + i) ^ n) -1. So, if monthly compounding rate is 2% for 24% APR, then EAR will be (1.02)^12 – 1 = 26.82%. EAR is higher than APR always.