Question

APR and EAR - Should lending laws be changed to require lenders to report EARs instead of APRs? Why or why not? Provide a real world example

Answer 1

Yes, lending laws should be changed to require lenders to report EARs instead of APRs.

This is because EARs indicate the actual, effective interest rate paid, whereas APRs do not.

For example :

HSBC USA offers a personal loan at a rate of 7% APR.

However, the EAR is calculated as below :

EAR = (1 + (APR/n))ⁿ - 1

where n = number of compounding periods per year

EAR = (1 + (7%/12))¹² - 1

EAR = 7.23%

The APR thus understates the actual, effective interest rate paid. This is because the interest is compounded monthly.

Therefore, it is better for consumers (borrowers) to know the EAR rather than the APR