Why Is the APR Higher on Short-Term Loans?

Posted on 9th Aug, 2017 by Barbara Davidson

The annual percentage rate (APR) is a consumer financing tool used to compare one loan offering with another. APR is often confused with interest rate — it’s actually the cost of money borrowed expressed as an annualized rate.

Lenders are required by law to disclose the APR to consumers before issuing a consumer loan. Trusted lenders are transparent with their APR and it should be displayed openly on their website. But how does APR relate to loans? Let’s first take a step back to understand what makes up a loan.

A loan consists of five basic elements: interest rate, fees, loan amount, loan term and payment.

The APR looks at all charges required by or incurred on a loan, including all interest charges.

The APR number indicates the cost of borrowing. Along with an interest rate, a lender may also require other fees before a loan can be issued, including loan-processing fees, loan application expenses or charges for credit report processing. These kinds of finance charges are considered as part of the overall cost to borrow money.

The annual percentage rate reflects those additional costs including the interest rate. The higher the loan fees, the higher the APR is in relation to the interest rate.

For example, a 30-year loan of $200,000 with a 5 percent rate has a monthly payment of $1,073. If the lender also charged a $500 application fee and a $2,000 origination charge, additional fees would total $2,500. This additional $2,500 in finance charges would result in an APR of 5.22 percent.

Typically, APR is higher for short-term loans. Often times a higher interest rate is associated with a person’s credit worthiness, but another factor could be the repayment window which maybe much shorter (two weeks — month). Short-term loans are intended to meet the needs of those in emergency situations with limited options for funding. Unlike long-term loans, like installment loans (usually six months or more), short-term loans are meant for dire circumstances like car failure, emergency home repair, unexpected medical bills and the like.

A shorter term can increase the APR as is that the borrower pays off the loan in a short period of time. This is particularly true if the non-interest finance charges are fixed regardless of the loan term.

If you’re wondering whether a long-term loan is right for you, check out this page to learn more!

About Barbara Davidson

Babs is Lead Content Strategist and financial guru. She loves exploring fresh ways to save more and enjoy life on a budget! When she’s not writing, you’ll find her binge-watching musicals, reading in the (sporadic) Chicago sunshine and discovering great new places to eat. Accio, tacos!