The statement “it is typically expressed as an annual percentage of the loan outstanding” refers to the concept of interest rates in the context of loans. Let me break it down for you:
The interest rate is the cost of borrowing money, and it is typically expressed as a percentage of the loan amount. It represents the compensation a lender receives for providing funds to a borrower.
Annual Percentage Rate (APR):
The annual percentage rate is a standardized way of expressing the total cost of borrowing on an annual basis. It includes not only the nominal interest rate but also any additional fees or costs associated with the loan, such as origination fees or closing costs.
The term “loan outstanding” refers to the remaining amount of the loan that has not been repaid. As you make payments on a loan, the outstanding balance decreases.
When we say that the interest rate is expressed annually, it means that the rate is stated as a percentage of the loan amount for a one-year period. Even if the loan term is shorter or longer than a year, expressing the rate on an annual basis allows for easier comparison between different loans.
Here’s a simple example to illustrate:
Suppose you borrow 100,000 PHP with an annual interest rate of 8%.
Loan Amount: 100,000 PHP
Annual Interest Rate: 8%
- Expressed Annually: The annual interest would be 8% of 100,000 PHP, which is 8,000 PHP. So, if you held the loan for one year, you would owe an additional 8,000 PHP in interest.
- Expressed Monthly: If the interest is compounded monthly, the monthly interest rate would be 8%/12, which is approximately 0.67%. After the first month, you would owe 0.67% of the remaining balance as interest. This process repeats each month, and the interest for the next month is calculated based on the remaining outstanding balance.
- For example, after the first month:
- Outstanding balance: 100,000 PHP – (0.67% of 100,000 PHP) = 99,330 PHP
- Interest for the first month: 0.67% of 99,330 PHP = 665 PHP
- This process continues, and after a year, the total interest paid would be the sum of the monthly interest amounts.
Remember that the actual amount paid could be higher if there are additional fees or charges associated with the loan. The Annual Percentage Rate (APR) would account for these additional costs and provide a more comprehensive view of the total cost of borrowing.
In summary, expressing the interest rate as an annual percentage of the outstanding loan balance allows for a standardized way to communicate the cost of borrowing, making it easier for borrowers to compare different loan offers.