An Essay on the Inadequacy of APR as a Measure of the Cost of Consumer Credit, and Why Consumer Credit Legislation Should Be Revised
38 Pages Posted: 30 Dec 2010 Last revised: 25 Mar 2011
Date Written: March 1, 2011
Abstract
This article maintains that the annual percentage rate (APR) is not an adequate measure of the cost of a consumer loan and therefore the central role of APR in consumer credit legislation should end. For decades, researchers, consumer groups and financial institutions have argued for simpler consumer credit legislation. Legislation in many countries is based on the Truth-in-Lending Act in the US. Much of the legislation is complex, and to a large extent the complexity is because APR is designated the most important measure of the cost of credit. There is abundant evidence that consumers find APR confusing and prefer a simpler measure, the finance charge. Conventional analysis argues that APR is the best measure and should retain its key role. In this article, mathematical arguments are deployed to challenge conventional analysis. It is demonstrated that (a) the finance charge and the concept of APR convey the same information therefore legislative emphasis on APR is unnecessary, and (b) orthodox APR is an inadequate measure of the cost of a loan.
Keywords: APR, consumer credit, complex plane, truth-in-lending
JEL Classification: C02, G20, G21, G28
Suggested Citation: Suggested Citation
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