One of the most crucial factors to consider when choosing a personal loan is the amount of interest attached to it. Typically, you'd want to get a personal loan with the lowest interest rate to save up on money. But interest rates can sometimes be a bit more complicated than that. So, here’s a simple guide to help you understand personal loan interest rates better.
What Is APR?
APR stands for annual percentage rate. This is the calculation of the interest rate, along with other fees and charges, to determine the total cost of borrowing money. Every personal loan has an APR rate, and to give it a number, the interest rate must be calculated over the entire year.
APR rates are beneficial when you want to compare two personal loans side by side, or when you want to get a rough estimate of how much you'd end up paying the lender in addition to the principal amount. However, it's not the best way to calculate the cost of borrowing money because it's not an effective measurement of the actual cost of the loan, which is the real interest rate.
Example: If you have a personal loan with an APR rate of 20.99%, that means that you'll pay 20.99% interest per year on your loan. The total cost of the loan will be calculated by taking the interest rate, multiplying it by the principal amount, and then dividing the result by 12.
So, if you're going to borrow $10,000, choose a personal loan with the lowest APR rate you can find.
What Is APY?
APY stands for annual percentage yield. This is the rate of the interest you'll pay on a personal loan, plus the total amount of interest that is estimated to be earned in the year. The annual percentage yield is most often used in lending to determine the real interest rate of a personal loan.
Essentially, APY is an advancement of APR. Since APR rates are calculated over the whole year, they don't take into account the compounding effect of interest. For example, if you are paying 20.99% interest per year, that is the same as paying 4.63% in a month. That's still a high-interest rate, but if you consider the fact that you'll be paying the amount for a whole year instead of a month, you'll be able to estimate the real cost of borrowing money.
What Is the Average Interest Rate for Personal Loans?
The average personal loan interest rate varies depending on the purpose of the loan. For example, if you're taking out a loan to consolidate your debts, you can expect to pay a higher interest rate than if you're taking out a loan to pay for school.
Personal loan rates are also dependent on the repayment terms. If you're taking out a loan for a term of five years and paying for it in installments, you can expect to pay a higher interest rate than if your loan is for a term of just one year.
Naturally, the interest rates vary from lender to lender and from country to country. In the United States, the interest rate varies from 2% to 26%. The average interest rate in the U.S. is at 13.47%. In the same country, average interest rates for different purposes are 3.2% for debt consolidation, 12.08% for school expenses, and 12.5% for medical bills.
It is always a smart idea to take a look at the terms and conditions of a personal loan before you apply for one. Although APR and APY are good ways to determine the cost of borrowing money, you should always know the real interest rate when you're choosing a personal loan.
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