APR vs. EAR

This can be a little confusing, but APR (annual percentage rate) is not the accurate annual interest rate. APR is intended to make it easier to compare lenders and loan options, by providing a standardized cost of borrowing.

But while most credit cards are quoted in terms of nominal APR compounded monthly or daily, the more direct reference for the one-year rate of interest is EAR (effective annual interest rate).

The general conversion factor for APR to EAR is EAR = (1+APR/n)^n)-1, where n represents the number of compounding periods of the APR per EAR period (typically 12 months). The result is a slightly higher interest rate, since a 19.99% APR equates to a 21.93% EAR.

While these differences may seem marginal, because of the compounding nature of credit card loans, nominal disparities can have drastic results over a lengthy term.

20 responses to “APR vs. EAR”

1. Fahed Essa

When is APR greater than EAR? what is the situation that introduces such circumstances.

My professor at wharton asked us this and i am confused.

2. EAR increases relative to APR as the number of compounding periods increase. Assuming annual compounding, the two rates are the same. As such, the only situation I can think of, when APR could be greater than EAR, is when the compounding period becomes a fraction of a year.

3. DC

EAR can never be less than APR only equal and equal when there is no compounding meaning only one month of payment.

4. Brian H

EAR can be less than APR if the compounding occurs less than once per year (i.e. interest accrues once every 2 years).

5. Ari

Yep Brian said it right. Think about it as a graph. The more periods you have, the greater the difference grows between APR and EAR, so the less periods the have is the opposite. It never really occurs in real life, but if your interest was compounded bi-yearly the APR would actually be greater than the EAR. A Wharton student should definitely know that…i’m completely shocked no one in your class knew the answer to that (which makes me to believe your lying about that, but forget about it). I am at the Kelley School of Business at Indiana University and you would be laughed at if you couldn’t figure that out. Are you an undergraduate? I guess if you were a freshman or something I could understand that, but still I remember my professors basically requiring you know the basic terms of business even during the first year. It’s just hard for me to believe that my business school (which has a very good reputation, but nothing compared to Whartons) expects more out of us than UPenn.

• baum

you are a tool

6. Anonymous

Shut Up and just answer her question. She never said no one in her classroom knew the answer, she just said she did not know the answer.

7. May the words you speak today, be tender, warm, and sweet;
For tomorrow they may well be the words you have to eat.
I can’t believe that Ari could be so careless with his words. That is not the way to make friends in any world, let alone the business world.

8. Anonymous

Amen, Andrea

9. Fahed Essa

This is Fahed speaking… a couple of years later that is! I was a molecular biology major, that was my first finance class, and the professor asked us to think about it over the weekend. Given i had no prior background, i referred to people that might know a little something about finance. I find it offensive to target anybody the way you did Ari. You have made assumptions about me, about UPenn and about Wharton; we all dont deserve this. As for me, i was a molecular biologist, masters in bio medical engineering and now work in the finance world. So i don’t think UPenn gave me a bad deal.

10. cora

We are discussing EAR verses APR. I undertand difference. What is puzzling be is the formular. I know the formular is (1+apr/n (compounding year) Power up n)-1. I keep coming up with error message when i enter formlarin excel. whatam i doing wrong. example =(1+apr/n)^ n (donot understand the power up symbol(^) )-1. I need to know how i enter this on excell spread sheet. Example APR=19.99 I donot come up with 21.93 EAR
what am i doing wromng. simpify this for me. It cannot be this hard

When is APR greater than EAR? Easy. When there is a fee (such as origination fee or points in mortgages).

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14. Jared

I understand that part. What I don’t understand is why is EAR more accurate. If a credit card company says they’re charging 10% APR, then how can it be more than 10%? Thanks in advance.

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16. anonymous

when will the APR be the same as EAR

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