APR calculation in laymans terms

A

agentino

Registered User
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I am going to aks a question that probably has been asked before but never in terms as simple as this.
My Ethos going forwrd in life is that I am no longer going to accept a Mantra or a saying or a term that has been used for such a long time it is now a fact without fully investigating it.

The Term in this instance is
"Because mortgage loans are calculate with APR interest then all the interest is front loaded and therefore the prinicipal does not decline in the early years"

I have heard that term everytime I have questioned my mortgage repayments. What does it mean? I don't have a clue and have spent 2 weeks on Google after spending 3 months trying to get my mortgage provider to engage with me and still am none the wiser.

At a high level I have a €312,500 mortgage over 35 years that I have been paying for 8.5 years (24.5% of the lifetime of the loan has passed) yet only 14% of the prinicpal has been paid.
Does that sound right. The rate was a variable rate for the first 3.5 years swapping to a tracker rate for the last 5 (I am assuming that does not matter)

Please don't point me to an APR calculator. I guess without knowing the exact interest rate breakdown it is a hard thing to quantify.

None the less it is a worthy question. How many of us are paying over 50% of our total income on this payment that we know next to nothing about ?
 
agentino said:
The Term in this instance is
"Because mortgage loans are calculate with APR interest then all the interest is front loaded and therefore the prinicipal does not decline in the early years"

...

What does it mean?
Click to expand...
Does the Amortisation Graph view and other repayment tables of Karl Jeacle's mortgage calculator clarify anything at all for you? In particular the repayment tables outlining the capital/interest split of repayments over the lifetime of the mortgage?

http://www.drcalculator.com/mortgage/ie/
 
Actually that sentence doesn't make a lot of sense in that the interest is not really front loaded as in it's not all added on at the beginning. It's just the amount borrowed is so large that the bulk of the repayments in the early years is just paying the interest. As the small amount of capital being repaid gradually reduces the interest being charged reduces also so the proportion of your monthly payment going to pay capital slowly increases over the years and really starts to accelerate towards the latter years.

If the payments were to be calculated differently so that for example every month you paid the interest for that month plus say 1,000 then the payments in the early years would be huge and unaffordable.

The principle does decline in early years, albeit slowly and the APR is really neither here nor there, the amount of interest being charged on a monthly basis is based on the o/s balance and the actual rate being charged. You can work out a rough approximation yourself if you know the balance at the beginning of the month and the rate, your monthly payment that month will reduce your capital by the amount of your repayment less the interest amount assuming there is no insurance included.
 
Not quite sure what you are asking. APR has nothing to do with how standard annuity mortgages work. APR is simply the annual percentage rate. It allows rates to be compared much easier.

This has nothing to do with why you are paying mostly interest at the beginning of a mortgage. That's simply the way annuity mortgages work.
 
agentino said:
At a high level I have a €312,500 mortgage over 35 years that I have been paying for 8.5 years (24.5% of the lifetime of the loan has passed) yet only 14% of the prinicpal has been paid.
Does that sound right.
Click to expand...
Looks plausible to me judging by the Annual Table view of Karl's calculator and using a representative interest rate of 5%.
 
In effect, on year 1, you pay interest on the whole of the amount borrowed + some part of the capital borrowed
In year 2, you pay interest on the whole of the amount borrowed - capital repayed in year 1
In year 3 you pay interest on the whole of the amount borrowed- capital repayed in year 1+2

However because the monthly payment you make remains the same (let's assume there is no interest rises) then as the amount you are paying in interest falls (as theamount outstanding falls), the portion you are paying against the overall amount borrowed rises
 
All,
Thanks for the replies to date. Don't for a second think I know what I am talking about. I am just a regular joe soap punched senseless by the recession looking at every Bill and outgoing I have trying to make sense of it.

From reading all the replies I think I may have it figured out. The APR talk was throwing me off and I think it is WBSS put in a manner I could understand

So I borrowed 312,500 over 35 years at a rate that is average 5% for year 1.

312,500 by .05 = 15625 in interest in year 1. Let's say payments of an average of €1350 per month =16,200. So 600 a year paid of the prncipal and so on. Obviously the longer the term of the mortgage the worse for the principal.
 
agentino said:
312,500 by .05 = 15625 in interest in year 1. Let's say payments of an average of €1350 per month =16,200. So 600 a year paid of the prncipal and so on. Obviously the longer the term of the mortgage the worse for the principal.
Click to expand...

Yes, you're definitely getting it.

Instead of explaining it as an APR impact, it is better to explain it as a compound impact.

You only chip away small amounts of capital at the start, but even these small amounts build up as time passes, accelerating the amount of your payment that actually goes towards paying down your original borrowing rather than just the interest.

For info, if the interest rate was 4% on a 35 year loan it would take 23 years before you'd paid off half the borrowings. For 8.5 years, 14% looks fairly reasonable.
 
Yes, you have pretty much got the concept now I think. Far too much emphasis is put on APR, its not that helpful an indicator.
 
wbbs said:
Yes, you have pretty much got the concept now I think. Far too much emphasis is put on APR, its not that helpful an indicator.
Click to expand...

APR is a useful and legally required number that must be disclosed for any credit product offerings in Ireland

From here

[broken link removed]

"In Ireland, the Annual Percentage Rate (APR) is the interest rate that reflects the real cost of borrowing to the consumer. It is defined as "being the total cost of credit to the consumer expressed as an annual percentage of the amount of credit granted". APR values are commonly used to compare loan programmes from different lenders in the market. You will probably have seen APR values on advertisements from lenders, where the APR value is expressed beside the rate for the loan. This means that consumers can shop around so they can ensure they select the best option."

1: If a borrower pays 11 euro interest on a one year loan of 100 euros, drawn down in full on 01/01/2010 and repaid in full on 31/12/2011: the APR is 11%

2: If a borrower pays 10 euro interest on a one year loan of 100 euros, drawn down in full on 01/01/2010 and repaid in full on 31/12/2011, and in addition pays one euro in arrangement fees: the APR is 11%

£: If a borrower pays 1 euro interest on a one year loan of 100 euros, drawn down in full on 01/01/2010 and repaid in full on 31/12/2011, and in addition pays ten euro in arrangement fees: the APR is 11%

However, the interest rate on each loan
is
1: 11%
2: 10%
3: 1%

which is why the code was brought out.

The math behind annuity payments is not difficult either.

All that is being done is a number is being calculated that will repay the loan plus the interest over a fixed term by way of equal payments.

The calculation is further muddied when people mention compound interest.

Compound interest will always arise when the frequency of repayments by the borrower is less than the the frequency for calculating interest.

Banks normally calculate interest on a daily basis so unless you make repayments daily, compound interest arises.

Given that each payment must at least include the interest due up to the date of the payment then the payment must always be greater than the compounded interest due

Below in the first array,is the data on a 100 euro loan for 1 year with daily payments at 4%: note that the interest amount repaid drops a little each day and the principal repaid increases

The annuity calculation just makes the sum of i plus P the same at 0.28

The i payment for day one of 0.0109589041095890 [100 * 4%/365] is what the daily payment would be if the loan was i only

The i payment for day two of 0.0109294745545958 {99.73 * 4%/365] reflect the reduction in principal of 0.268544689313438 in the 0.28 paid on day 1





Month.....Payment....Interest....Principal. Balance
00................................................................................100.00
01 0.28 0.0109589041095890 0.268544689313438000 99.73
02 0.28 0.0109294745545958 0.268574118868432000 99.46
03 0.28 0.0109000417744459 0.268603551648582000 99.19
04 0.28 0.0108706057687858 0.268632987654242000 98.93
05 0.28 0.0108411665372621 0.268662426885765000 98.66
06 0.28 0.0108117240795212 0.268691869343506000 98.39
07 0.28 0.0107822783952097 0.268721315027818000 98.12
08 0.28 0.0107528294839737 0.268750763939054000 97.85
09 0.28 0.0107233773454599 0.268780216077567000 97.58
10 0.28 0.0106939219793144 0.268809671443713000 97.31
.
.
.

Just to finish off on this point
see this table which is 100 at 4% for a year, showing the monthly annuity payments and the i and P components
00 100.00
01 8.49 0.3333333333333330 8.181657086222220000 91.82
02 8.49 0.3060611430459250 8.208929276509630000 83.61
03 8.49 0.2786980454575590 8.236292374098000000 75.37
04 8.49 0.2512437375438970 8.263746682011660000 67.11
05 8.49 0.2236979152705250 8.291292504285030000 58.82
06 8.49 0.1960602735895750 8.318930145965980000 50.50
07 8.49 0.1683305064363540 8.346659913119200000 42.15
08 8.49 0.1405083067259540 8.374482112829600000 33.78
09 8.49 0.1125933663498560 8.402397053205700000 25.38
10 8.49 0.0845853761725040 8.430405043383050000 16.95
11 8.49 0.0564840260278921 8.458506393527660000 08.49
12 8.49 0.0282890047161313 8.486701414839430000 00.00

The 0.3333333333333330 is an interesting number

It is (100 * 4%/12) which suggests that the interest is not compounded in the calculator I am using.
 
hastalavista said:
1: If a borrower pays 11 euro interest on a one year loan of 100 euros, drawn down in full on 01/01/2010 and repaid in full on 31/12/2011: the APR is 11%

2: If a borrower pays 10 euro interest on a one year loan of 100 euros, drawn down in full on 01/01/2010 and repaid in full on 31/12/2011, and in addition pays one euro in arrangement fees: the APR is 11%

£: If a borrower pays 1 euro interest on a one year loan of 100 euros, drawn down in full on 01/01/2010 and repaid in full on 31/12/2011, and in addition pays ten euro in arrangement fees: the APR is 11%
Click to expand...
You've got an extra year in each of these examples - 01/01/2010 to 31/12/2011 is two years, not one. And to be exact, the repayment should be the same day otherwise you are looking at a 364 day not a 365 day loan. Your examples are correct if looked at from 01/01/2010 to 01/01/2011 (or any other full year period).
 
While APR is a legal requirement it is much more useful for the example you gave of very short term loans but the number of variations in rate there could be over the term of a mortgage make it less useful. If someone picks a 5 yr fixed on a 30 yr mortgage then the APR will be calculated on the 5 yr rate + 25 yrs of the variable rate at that time but that rate could change substantially over the years and the bank that had the best variable rate when you took out the mortgage could end up being the most expensive later so it's not helpful for long term borrowing. I think one of its main functions day one was to show which banks were dearer as there were application fees, acceptance fees, valuation fees, indemnity insurance etc and all these had to be factored in to APR, however when the feeding frenzy of lending started most lenders dropped all these fees making straight forward comparison easier. Cost per thousand is possible a better indicator of cost unless the rate is fixed for the full term.
 
Cost per 1000 can be manipulated in a variety of ways so unless the cost per 1000 is done exactly the same way then it can be abused.

I am not having a go at u here, your posts are a lot better than anything I can aspire to..

APR is clearcut, perhaps not easily understood, but is clearcut: A divided by B where A and B are clearly defined
 
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