# How do APR rates work **URL:** \ **Category:** Factual Questions\ **Created:** [January 8, 2004, 1:59am UTC](https://boards.straightdope.com/t/how-do-apr-rates-work/223340 "2004-01-08T01:59:50Z")\ **Posts on this page:** 4\ **Page:** 1
**Author:** ![Wesley\_Clark](https://sea3.discourse-cdn.com/straightdope/user_avatar/boards.straightdope.com/wesley_clark/32/20581_2.png) [@Wesley\_Clark](https://boards.straightdope.com/u/Wesley_Clark)\ **Post date:** [January 8, 2004, 1:59am UTC](https://boards.straightdope.com/t/how-do-apr-rates-work/223340/1 "2004-01-08T01:59:50Z")
How does interest on a loan work? i assume it works like this but i could be wrong, can someone fill me in. you get a 10 year loan at 5% APR (fixed rate) for $10000. That works out to $83.3 a month for 120 months if you just had to pay back the $10000 with 0% interest. Is APR determined by taking 5% of that $10000 ($500 year/$41.67) and adding it to the $83.3, coming up with $125 month total or is APR determined in some totally different fashion. does the APR drop as the loan is payed back or does it remain static and based on the original loan amount? ---
**Author:** ![Wesley\_Clark](https://sea3.discourse-cdn.com/straightdope/user_avatar/boards.straightdope.com/wesley_clark/32/20581_2.png) [@Wesley\_Clark](https://boards.straightdope.com/u/Wesley_Clark)\ **Post date:** [January 8, 2004, 2:00am UTC](https://boards.straightdope.com/t/how-do-apr-rates-work/223340/2 "2004-01-08T02:00:54Z")
> [@](#): > > \*Originally posted by Wesley Clark \* > \*\* ($500 year/$41.67) > \*\* that should say ($500 year/$41.67 month) ---
**Author:** ![Art\_Barber](https://avatars.discourse-cdn.com/v4/letter/a/edb3f5/32.png) [@Art\_Barber](https://boards.straightdope.com/u/Art_Barber)\ **Post date:** [January 8, 2004, 3:42am UTC](https://boards.straightdope.com/t/how-do-apr-rates-work/223340/3 "2004-01-08T03:42:03Z")
No. The interest you pay every month is not constant, although the percentage is. Here’s the deal: For simplicity, say the interest rate is 12%. The first month, you pay 1% of the total amount (called the principal) you owe plus a part of the principal. So, you’d pay $100 plus a small amount of the principal (I’ll call it A). The next month, you’d pay 1% of (10,000 - A) plus another part of the principal (say, B). So, the interest RATE is the same, but the interest AMOUNT is less. However, since the monthly payment is constant, that means the reduction in principal is greater than the previous month, i.e., A is less than B. By this means, each sucessive month is composed of less interest and more principal reduction. The initial value of the first principal reduction depends both on the amount of the loan and the number of months to pay it off. I could sit down and figure out how bankers figure it out, but I’m too lazy (whaddya want for free). Tiny principal reductions mean the monthly payment is low, but the loan term is long. In fact, for things like houses, it’s possible to get an “interest only” loan, which is just what it sounds like: no principal reduction at all. I think you pay off the principal in one huge chunk after an agreed upon time. This can be advantageous because if the house appreciates, you can sell it for a profit, pay off the loan, and have money left over (meanwhile, all of the interest you are paying is tax deductible). Alternately, you can refinance the house again (not necessarily at the same interest rate). Art ---
**Author:** ![Ringo](https://avatars.discourse-cdn.com/v4/letter/r/779978/32.png) [@Ringo](https://boards.straightdope.com/u/Ringo)\ **Post date:** [January 8, 2004, 4:04am UTC](https://boards.straightdope.com/t/how-do-apr-rates-work/223340/4 "2004-01-08T04:04:24Z")
When contemplating financing, be aware of the widely applied [**Rule of 78s**](http://www.in.gov/dfi/consumer/rule78s.htm). > [@](#): > > The Rule of 78s is also known as the sum of the digits. In fact, the 78 is a sum of the digits of the months in a year: 1 plus 2 plus 3 plus 4, etc., to 12, equals 78. Under the rule, each month in the contract is assigned a value which is exactly the reverse of its occurrence in the contract. Hence, the 1st month of a 12 month contract gets the value of 12, the second month 11, etc., until the 12th month gets a value of 1. As the months elapse, the interest is earned by the lender equal to the total value of the expired months. > > For example, prepaying after 2 months of a 12 month contract would result in the lender being able to keep 29.48% of the finance charges (1st month 12 plus 2nd month 11 = 23/78 or 29.48%). In another example, if the borrower prepays after 6 months, the lender would have earned 57/78s or 73.08% of the finance charges.