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.
3 responses so far ↓
Fahed Essa // February 15, 2009 at 3:48 am |
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.
creditbrain // February 16, 2009 at 12:48 pm |
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.
DC // May 20, 2009 at 10:25 pm |
EAR can never be less than APR only equal and equal when there is no compounding meaning only one month of payment.