What an APR includes, and what it leaves out

What the number is built from

An APR is the periodic rate that makes your scheduled payments worth exactly the cash you received, multiplied by the number of periods in a year. Three inputs go in: the amount you actually get, the amounts you pay, and the dates. Anything the calculation is told to treat as a finance charge moves the answer. Anything it is told to treat as something else does not.

That last sentence is where most of the confusion lives.

Identical money, two different APRs

Illustrative only — $100,000 over 24 monthly payments at a 12% nominal note rate. The payment is $4,707.35 and the total repaid is $112,976.40.

Now add a $3,000 fee. One lender deducts it at funding and includes it in the finance charge: you received $97,000, so the rate that discounts 24 payments of $4,707.35 back to $97,000 is 1.2575% a month, and the APR is 15.1%. Another lender charges the same $3,000 as a separately payable processing charge and quotes the APR as 12.0%.

You are $15,976.40 out of pocket in both cases. The gap between the two quotes is 3.1 percentage points and none of it is money.

There is no federal referee for this on business credit. The Truth in Lending Act and Regulation Z, which standardise what goes into a consumer APR, exempt credit extended primarily for business, commercial or agricultural purposes — see 12 CFR 1026.3(a). A business APR is a computation someone chose to run, not a disclosure they were compelled to standardise. State commercial financing disclosure laws in New York and California now require an APR or estimated APR on covered transactions, and they specify what goes in; outside their scope the term means whatever the quoting party meant by it.

What an APR never captures

A higher APR can be fewer dollars

Illustrative only — $100,000 at a 24% nominal rate over six months costs $7,115.48 in interest. The same $100,000 at 12% over 24 months costs $12,976.40. The 24% deal charges twice the rate and costs 45% fewer dollars, because it is outstanding for a quarter of the time.

This is not a trick, it is the definition. An APR is a price per unit of time. Dollars are the price. If you are choosing between a fast expensive facility and a slow cheap one, the rate answers a question you may not be asking.

The day-count convention, which produces three answers from one schedule

On a daily-debit product the annualising step is not obvious, and the convention chosen moves the answer more than most fees do.

Multiply by the 252 banking days in a year: 45.8%. That is the nominal annual rate on the correct basis, because the debit only happens on banking days.

Multiply by 365, as though the debit ran every calendar day: 66.4%. Wrong, and inflated.

Compound the 252 periods instead of multiplying them: 58.0% effective.

Three numbers, one schedule, no dishonesty required to produce any of them. Whenever you are shown an annualised figure on a daily or weekly product, ask how many periods a year were used and whether the rate was multiplied or compounded. If the answer is not immediate, the number was copied rather than calculated.

How to use it anyway

The APR is the right tool for one job — putting two structures on the same axis when their pricing conventions differ. Use it that way and it earns its place. Just make it your own calculation rather than theirs.

1. Get the cash figure: amount funded minus everything deducted at funding.
2. Get the payment schedule: amount, frequency, number of payments.
3. Solve for the periodic rate on those two things, and multiply by periods per year. The calculators will do it, and so will the RATE function in any spreadsheet.
4. Add back the fees the lender excluded, and run it again. The difference between your two answers is the size of the argument.
5. Write the total dollars beside the rate, always. The pair is honest. Either one alone is not.

If a funder will not give you the schedule in writing, you cannot compute an APR, and neither can they. That refusal is itself an answer.

The email that gets you a usable answer

You cannot compute any of this from a quote. You can compute all of it from a schedule, so ask for the schedule rather than arguing about the rate.

1. The dollar amount that will be credited to our account on the funding date, after every deduction.
2. Every payment: amount, frequency, first date, and how many.
3. Anything payable at the end of the term.
4. A list of amounts payable at or before funding, and whether each is treated as a finance charge in any rate you have quoted us.
5. Whether the rate you quoted is nominal or effective, and the number of periods a year behind it.

Five lines. A lender that answers all five has given you everything you need to reproduce its number and to compare it against anyone else's. A lender that answers the first three and not the last two has told you the rate came from marketing rather than from the schedule.

Where an APR is the wrong tool entirely

Three situations where the number will mislead you even when it is correctly computed.