Money Maths Made Simple
The True Cost of a Loan: Fees and APR
How processing fees, insurance and other charges raise the real cost of a loan above its interest rate, and how the annual percentage rate captures this.
Two loans with the same interest rate can cost very different amounts. The difference is usually in the fees.
Common charges
- Processing fees, often 1 to 3 percent of the loan.
- Documentation and login charges.
- Insurance bundled with the loan.
- GST on fees.
- Prepayment or foreclosure charges on some loans.
- Late payment penalties.
An example
A 1 lakh rupee personal loan at 12 percent reducing for 12 months has an EMI of about 8,885 rupees. But suppose the lender charges a 3,000 rupee processing fee, deducted upfront. You receive only 97,000 rupees but still repay the same EMIs.
Your true cost is now around 18 percent a year, not 12, because you pay interest and fees on money you never received.
The shorter the loan, the more a fixed fee raises the effective rate.
The annual percentage rate
The annual percentage rate, or APR, combines the interest rate and most fees into a single yearly cost. It lets you compare loans with different fee structures on equal terms.
In India, the RBI requires banks and regulated lenders to give borrowers a key fact statement showing the APR and all charges for retail and small business loans, before the loan is signed.
How to compare loans
- Ask for the key fact statement.
- Compare the APR, not just the headline rate.
- Check the total amount repayable.
- Read the terms on prepayment and late fees.
- Question any bundled insurance: is it required, and is it good value?
Digital lenders
Some digital lending apps advertise low daily or monthly rates, such as “just 0.1 percent a day”, which is about 36 percent a year before fees. Converting to an annual rate reveals the real cost.
A borrower is offered a loan at an attractive rate but finds that a mandatory insurance premium of 5,000 rupees has been added. Including this, the APR on the key fact statement is several points higher than advertised. She compares it with another lender and saves money.
Fees, insurance and taxes can add significantly. The APR and total repayable amount show the true cost.
- Processing fees, insurance and other charges raise a loan's true cost.
- A 3,000 rupee fee on a 1 lakh, one-year loan at 12 percent lifts the cost to about 18 percent.
- The APR combines interest and fees into one comparable number.
- Indian lenders must provide a key fact statement showing the APR.
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