Interest Rates on Loans

Lending institutions frequently cite an annual percentage rate or APR. This is based on an approximate formula for the interest rate, and it can be close to the correctly computed interest rate. For example, a lender might claim an APR of 12.41% per year, whereas an engineering economist might compute the interest rate to be 1% per month, so the effectively yearly rate is 12.68% (1.0112-1). The difference between the claimed rate of 12.41% and the computed rate of 12.68% is small in this case. However, major differences in claimed versus computed interest rates occur if lenders and borrowers use different sets of cash flows, as explained in the following section.