If you are planning to take a loan, then it is important for you to know the concept of ROI and APR. A clear understanding of these terms will empower you to compare between lenders and various loan offerings

Let us understand this further and how it’s calculated.

 

What is ROI?

The Rate of Interest is the amount a lender charges a borrower and is a percentage of the principal—the amount loaned. The interest rate does not include any other fees charged for the loan

 

What is APR?

The Annual Percentage Rate is the total annual cost of your loan expressed in percentage. It includes the yearly rate of interest charged by the lender and other fees levied such as processing fees, administrative charges, loan insurance costs, etc.

How are the ROI and APR calculated?

The ROI is set by the lender and is expressed as a percentage of the principal.

The formula to calculate the total amount payable (principal plus simple interest) is

A = (P(1+rt)), where

• A is the total amount due
• P is the principal borrowed
• R is the rate of interest
• T is the tenor of the loan

As an example, let’s say Alok has borrowed Rs 5 Lakh for a personal loan at anannual interest rate of 24% with a repayment tenure of 3 years. Alok also paid an upfront processing fees of 2% of the loan ie Rs 10,000.

Alok’s total amount payable using the above formula is [(500000 x (1+0.24 x 3)] = 8,60,000

The formula to calculate the total interest amount payable is Total amount due – Principal (A-P) which means in this case 8,60,000 – 5,00,000 = 3,60,000

In this case, the total amount paid by Alok is Rs 8,70,000 (500,000 towards principal + Interest of Rs 3,60,000 + Processing fee of Rs 10,000)

Now, let’s take the similar example of Alok to calculate the APR.

Interest payable as calculated above is 3,60,000

The formula used to calculate APR is: [{(Interest + Other Fees) / Principal} / Duration of the loan in years] x 1 x 100

so the APR is {(3,60,000 + 10,000) / 5,00,000} / 3] x 1 x 100 = 24.67%

As we see, Alok’s actual loan cost is coming at 24.67%, which is higher than the annual interest rate of 24 %

To summarise the APR of 24.67 % is the same as paying a ROI of 24% with a 2% processing fee.

Other Important Aspects to Consider

• Your credit score is one of the most important factors that affect your ROI and APR. A score upwards of 750 is likely to get you a competitive interest rate, better repayment terms, and lesser overhead costs, thereby reducing your APR.
• Your annual income, expenses, and other ongoing loans also have a bearing on the ROI and APR you will finally be offered.
• Higher amounts and longer repayment tenures usually come with lower ROIs and APRs. However, the key is to only borrow as much as you can comfortably repay on time. Missing EMI dates will adversely affect your credit score making it difficult for you to borrow in the future.
• Additionally, borrowers must be aware that lenders can adjust the APR as deemed necessary. However, they are required to notify the borrowers prior to making this modification. Moreover, it is also important for borrowers to know that lenders are required to be transparent and publish the APR on the loan agreement.

 

Bottom Line

It is important to remember the distinction between ROI and APR and treat them separately. Most people make the mistake of just checking the ROI (or treating both as the same) and using it as the main factor to calculate their cost of borrowing. As you now know, that is not the case.

Using the Annual Percentage Loan not only gives you a better idea on the cost of the loan beforehand, but also helps you choose the lender wisely and get the best loan deals. Therefore, whenever you apply for a loan ensure you confirm the APR with your lender before signing the loan documents

HDB Financial Services is one of India’s leading Non-Banking Financial Companies (NBFC) and offers various loans to meet your diverse personal and business requirements at attractive interest rates. HDB's collateral-free loans are tailor-made to your specific needs and repaying capacity with a promise of transparency in APR calculation that includes no hidden costs or charges.