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    All you need to know about APR for Student Loans

    Let’s start with the question: “what does APR stand for?”. APR is the Annual Percentage Rate of any loan, including student loans. Sounds quite self-explanatory, right? Well, almost.

    As you may have guessed, it refers to the percentage of interest you will pay for your student loan per year and is essentially the cost of borrowing that money.

    However, there are some important calculations to know about, some nuances which could make all the differences, and some important distinctions to be made between the term APR and other terms such as “interest rate”.

    What is APR? How is it calculated?

    How is it different from other similar terms, and why does it all matter?

    Let’s dive in to find out. 

    What is APR? 

    As mentioned, APR is the annualized percentage of interest paid for a student loan. However, there are two important characteristics of it everyone should know about: 

    1. APR includes any fees or additional costs associated with the loan, and therefore is more final and comprehensive than other rates. Under the Truth Act, lenders are required to provide this calculation, to help you understand the final, full picture of your expenses associated with the loan in question.

    2. APR does not take compounding within the year into account.

    More on this later.

    When talking about student loans specifically, APR typically includes the most common fee - loan origination. This is an upfront fee that is charged to process your loan application and can range anywhere from 0 all the way to a hefty 4%. 

    Also important to note, during forbearance (temporarily suspending your loan payments for any reason), interest will still be accruing. This case could also lead to a higher APR overall. Accordingly, the loan duration also affects the rate.

    How to Calculate APR 

    APR is calculated based on the loan amount, interest rate and loan term. You won’t need to calculate the APR yourself, as the lender will provide the final information to you. Also, there are easy online calculators. Still, it is good to get a feel for the math in order to enhance your overall understanding of APR.

    The formula is as follows:

    APR = (((FEES + INTEREST) ÷ (PRINCIPAL) ÷ n) x 365) x 100

    Interest = the total interest paid over the full duration of the loan

    Fees = associated costs/additional charges

    Principal = total loan amount

    n = the number of days in the loan term

    Let’s break it down.

    1. First you add up the total interest and all associated fees.
    2. Then, you divide this number by the number of days that make up the entire loan duration. For example, 5 years would be 5 x 365 = 1825 days. This gives us a daily rate. As mentioned, interest accrues daily but does not compound. So, you’ll pay 365 x the same daily interest for every day of the year. 
    3. Now we need to multiply our previous result by 365, to bring us to our annualized rate.
    4. The last step is to multiply the annualized rate by 100, to give us a percentage rate.
    5. This final percentage rate equals the APR, our Annualized Percentage Rate for this loan.

    APR Versus The Interest Rate

    The difference between APR and the interest rate can often be confusing. However, understanding the difference between the two is important. The interest rate refers to the percentage of interest you’ll pay for a loan.

    For example, if you take a loan of $100,000 and the interest rate is 5%, this basic concept is simple to understand - you need to pay back 105%. On the other hand, Annual percentage rate takes additional factors into account to reflect the real cost of the loan including fees along with the time it takes to pay the loan back.

    So, APR reflects the actual cost of getting a loan, over a certain number of years. The interest rate does not encompass the actual, final cost, but rather is part of the rate. Interest rates refer to a monthly view, whereas APR refers to total cost, bottom line, annually. Of course, in the context of student loans, APR is the rate you want to look at to understand the true picture of your total costs.

    APR Versus APY

    APY stands for Annualized Percentage Yield. Both APR and APY refer to the interest paid for a loan, but there is one key difference. APY is the effective rate of return, considering also the compounding interest factor. As mentioned, APR only takes into account the cost of the loan, without considering the compounding element.

    Let’s check out the APY formula below.

    APY = (1+ r ÷ n ) n - 1

    r = Annual interest rate 

    n = The number of compounding periods each year.

    For example, if you had a loan amount of $10,000 with an APR of 12% at a monthly interest of 1% of the balance or $100, the effective balance changes to $10,100 after month 1. The interest for next month will be $101, which when compounded over a year will clock around 12.68% of effective interest rate. 

    As we can see, APY encompasses the compounding nature of loans, “interest on interest”, while an APR does not. APY is typically higher than APR for this very reason.

    APR Versus Daily/Monthly Periodic Rates

    Unlike the Annual Percentage Rate, Daily Periodic Rate is the cost of the loan per day. APR divided by 12 will give us the Monthly Periodic Rate, while APR divided by 365 will give us the Daily Periodic Rate. 

    The simple formulas are as follows:

    APR ÷ 365 = daily periodic rate

    APR ÷ 12 = monthly periodic rate

    How can you use the APR to Make the Best Decisions?

    The student loan market can be confusing, and while not perfect, APR is a great way to understand final costs. This is especially useful when it comes to comparing various plans. APR simplifies the bottom line by including add fees which can sometimes be overlooked by loan-takers, as well as considering the time over which the loan would be paid.

    Let’s not forget that forbearance is a very real option for many students, and this affects APR too.

    The interest rates and origination fees offered when it comes to student loans can sometimes be negatively correlated. In other words, one can be cheaper than the market average, while the other is higher to make up for it. This is the main reason student loans can often be rather confusing. For this very reason, when shopping for student loans, it’s best to find out about APR and the interest rates, and this will help you to get the full picture, compare plans effectively and make smart decisions.

    The Bottom Line 

    When starting to look at student loans, it can be quite bewildering given the new terms to understand, strange acronyms, and the amount of math involved. By using APR, you can get a very straightforward picture of the real cost of your loan.

    Knowing the basics and the mechanics of loan calculations is crucial given it can save you a lot of money over time.