Whether you’re taking out a 30-year mortgage or whether you’re taking out a 14-day payday loan, your lender is usually required to tell you what the Annual Percentage Rate (also known as “APR) is for the loan. The APR is one way to compare the cost of a loan, so if you are considering loans from multiple sources you can compare the different products. APR is far from perfect, but it is a useful tool when you’re considering a payday loan, car loan or a mortgage.

Why do we use APR?

Borrowing money can be confusing. Banks and payday lenders and other lenders will throw out a lot of numbers that may mean different things. The Truth in Lending Act was a federal act that, among other things, required lenders to quote the APR to someone who is considering taking out a loan. They did this, ostensibly, to reduce some of the confusion in the marketplace.

What is APR?

APR lets you look at the costs involved in a loan in terms of percentages. A $100 loan with a 10 percent APR will charge you $10 per year. Obviously, since that scenario doesn’t involve paying off any principle, it’s not exactly the best example, but you get the idea.

The limitation of APR

Unfortunately, there are limitations. Your APR may include more than just the interest on the loan. It might include things like processing fees or even mortgage insurance on a home loan. You need to look at the APR in detail so you know what is and what is not figured in for any given loan. You need to know what charges and expenses are involved in a loan. Beyond that, you need to get the big picture and look at how long you’ll have the loan to decide whether or not it’s worth it.

Calculating APR

If you need help figuring out the APR on a potential loan, ask the lender. They are required by federal law to provide you with the APR on a loan. If you want to calculate it on your own, there are a number of online services that can help you do exactly that, as well.

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