How does Interest and APR work?

What is APR?

It is the annual percentage rate or effective interest rate that will be charged when you borrow money for a mortgage or personal loan.

APR or Annual Percentage rate can include things like:

• yearly cost of mortgage including mortgage insurance
• effective interest rate on consumer loans, where interest is computed monthly or other non-annual basis
• includes all fees (except penalties) and takes into account the continual reduction of principal amount through amortization

How does the frequency of compounding effect the real cost of borrowing?

If interest is compounded twice a year the interest paid will be more than if the interest was compounded once a year. If we were to compound the interest daily would increase even more, even though the interest rate stays the same the repayment amount increases because of compounding.

Let's look at an example:

Borrowed $100 for one year. 8% interest, compounded once a year. Total to be repaid: $100 x 8% = $8.00 + 100.00 = $108.00 (interest and principal)

Borrow the same $100 for one year. 8% interest compounded twice a year. Amount owing would be:
$100 x 8% / 2 = $4.00 + ($104 x 8% / 2) = $4.16 Total interest equals $4.00 + $4.16 + $100 principal =$108.16

Same $100 for one year. 8% interest compounded daily. Amount owing would be: $108.33

The APR will include any additional costs incurred by the frequency of the compounding.