Annual Percentage Rate (APR), or Truth in Lending APR, is a disclosure mandated by the Truth in Lending Act of 1968. It is designed to accurately disclose
the cost of credit and provide a standard basis of comparison for the costs of credit.
For example, when you go grocery shopping you have to decide what the better bargain is: $1.79 for a quart of milk, or $3.50 for a half-gallon? To come
up with the right answer, you'd need to know how to convert between quarts and gallons, or between either measure and ounces. Then again, you may end up
buying the quart because you only have $2—even though the half-gallon is cheaper per ounce.
Making decisions about the cost of credit poses similar, albeit less familiar, comparative hurdles. A number of factors—such as term, type of interest rate
(see below), a state’s usury laws, etc.—can effect the cost of credit and make it hard to evaluate multiple loans. The APR makes comparison shopping easy. Of course,
there are times when you may still end up taking a more expensive loan because the monthly payments are lower than other, cheaper loans.
Why is the APR higher than the borrower interest rate?
You will never pay more than the maximum interest rate you specify. However, the APR is higher because of the closing fee charged when you borrow money at Prosper.
The closing fee is paid out of the loan proceeds when the loan originates. While the amount financed is less than the amount
requested, you still need to pay back the full amount. For example, a B Prosper rating borrower receives $2,450 for a $2,500 loan, but pays back the full $2,500 over the term of the loan.
How does the type of interest rate used affect APR?
Not all interest rates are created equal. Prosper uses simple (or actuarial) interest rates. But types like add-on interest and discount interest have different costs.
In each case, the type of interest rate used can end up with very different APRs, for example:
