APR explained without unnecessarily complicated formulas

When comparing two loans, the first thing people often look at is the monthly payment. That is understandable: knowing whether you will have to pay 250, 300 or 400 euros a month is essential to deciding whether the debt is affordable. But the instalment alone does not tell you what the loan really costs. Even the TAN, the nominal annual interest rate, tells only part of the story. To compare two offers properly, you should focus particularly on the TAEG, the annual percentage rate of charge (APR), which represents the overall cost of credit expressed as an annual percentage of the amount financed. The Bank of Italy identifies it as the most useful indicator for comparing the overall cost of different offers. The difference between TAN and TAEG may sound technical, but it is actually very simple: TAN mainly measures interest, while TAEG seeks to include the other compulsory costs associated with the loan. That is why a loan with a lower TAN is not necessarily cheaper.

TAN and TAEG are not the same thing

TAN, the nominal annual interest rate, is the rate used to calculate the interest due on the borrowed principal. If a loan has a TAN of 6%, the interest calculation starts from that nominal rate, applied in accordance with the contract. TAEG has a broader purpose. The Italian Consolidated Banking Act defines TAEG as the total cost of credit to the consumer expressed as an annual percentage of the total amount of credit. This total cost includes interest and other charges, including commissions, taxes and other expenses known to the lender; the costs of ancillary services, such as certain insurance policies, may also be included when they are compulsory to obtain the credit or obtain it on the terms offered. In very simple terms:

This is why TAEG is normally equal to or higher than TAN. Imagine a loan of 10,000 euros with a TAN of 5%. Looking only at TAN, we might think the cost is relatively low. But suppose the contract also includes 250 euros in application processing fees, 150 euros in commissions and other compulsory costs associated with the loan. These charges do not necessarily change TAN, but they still make the loan more expensive. The following table presents two hypothetical offers, to be compared for the same amount, term and instalment schedule. The TAEG figures are independent illustrative values, not calculations based solely on the expenses in the previous example:

Looking only at TAN, loan A appears better. Looking at TAEG, however, B has the lower overall annual cost. That is precisely why TAEG was developed: to make comparisons more realistic between offers with different cost structures. The Bank of Italy specifically recommends using TAEG to compare loans offered by different intermediaries.

Why the instalment can be misleading

Suppose you have to choose between two loans for the same amount. The first requires a monthly payment of 300 euros for four years. The second requires 230 euros a month for six years. At first glance, the second looks much more attractive because it costs 70 euros less each month. But remember that you will make 24 additional payments. A lower instalment can be achieved simply by extending the loan term. This improves monthly affordability, but can significantly increase interest and the total cost. When assessing a loan, you therefore need to distinguish at least three questions: Can I afford the instalment? How much will I pay overall? What is the effective percentage cost of credit? TAEG mainly helps answer the third.

TAEG is not a percentage you can simply multiply by the principal

Another common misunderstanding arises here. If a loan of 10,000 euros has a TAEG of 8% and runs for five years, that does not mean the total cost will simply be:

TAEG does not work like simple interest applied every year to the entire original principal. The outstanding principal changes as instalments are paid, interest is calculated according to the repayment schedule, and expenses may be incurred at different times. TAEG is therefore a comparable summary indicator, not a quick formula for determining the exact total interest. To find out how many euros will be paid overall, you also need to look at the repayment schedule and the total amount payable by the consumer.

Which costs are included in TAEG?

For consumer credit, the total cost may include, besides interest, fees for opening and handling the application, taxes and any compulsory insurance policies. The Bank of Italy expressly states this in its consumer information materials. The Consolidated Banking Act includes in the total cost of credit the interest and other costs the consumer must bear in connection with the contract and of which the lender is aware. Ancillary services are also included when taking them out is necessary to obtain the credit or obtain it on the advertised terms. Notarial fees, by contrast, are excluded from the general definition of total cost of credit used for consumer credit. This detail helps explain why TAN and TAEG can sometimes differ substantially.

Suppose processing a loan application costs 300 euros. On a loan of 30,000 euros, that represents 1% of the principal. On a loan of 3,000 euros, it represents 10%. The same fee can therefore have a completely different impact depending on the amount borrowed. This is one reason why TAEG on small loans can be much higher than TAN. An offer advertised as “TAN 0%”, for example, is not necessarily free if compulsory charges apply. A loan can have a zero TAN and a positive TAEG. So the right conclusion is not: “The rate is zero, so I pay nothing.” What you need to check is: “What is the TAEG, and what is the total amount payable?”

Zero TAN with a non-zero TAEG

Imagine buying an item costing 1,200 euros, financed over twelve months at TAN 0%, but with a compulsory application opening fee of 100 euros. Interest is indeed zero. But to obtain 1,200 euros in credit, you repay 1,300 overall. The economic cost is therefore not zero. TAEG exists precisely to make these costs visible and allow the offer to be compared with a loan that might charge nominal interest but lower fees. That is why TAEG in advertisements is much more informative than the slogan “zero interest” alone.

TAEG and insurance

Insurance policies associated with loans deserve particular attention. An optional policy is not automatically included in the calculation in the same way, whereas if taking out an ancillary service is required to obtain the loan or obtain it on the proposed terms, its cost forms part of the total cost under the applicable rules. Suppose a loan is advertised with a TAN of 6%, but obtaining that specific rate requires an insurance policy costing 1,000 euros. That policy should not be regarded as unrelated to the economic cost of the transaction. The key question is: could I actually obtain that loan, on those terms, without incurring this expense? If the answer is no, the ancillary cost is economically part of the credit.

SECCI: the document to read before signing

There is a particularly useful document for consumer credit: SECCI, the Standard European Consumer Credit Information form. The Bank of Italy explains that SECCI must be provided free of charge before signing and contains information such as the amount, term, instalment, security, costs, TAN and TAEG, as well as information on the consumer's main rights. It is an important tool because it allows you to compare two loans using standardised documents, rather than just advertising slogans. Before signing a loan agreement, it should therefore be normal to compare at least:

• the amount actually disbursed;
• the term;
• the number and amount of instalments;
• TAN;
• TAEG;
• the total amount payable;
• ancillary costs;
• early repayment terms.

Simply asking “how much is the monthly payment?” is not enough.

Why two TAEGs should be compared for genuinely similar transactions

TAEG is very useful, but it too can be misused. To compare two loans properly, the amount, term and repayment arrangements should be the same or very similar. Comparing a loan of 10,000 euros over three years with one of 20,000 euros over ten years solely by looking at TAEG may not be very meaningful for the actual decision. TAEG allows you to compare the relative cost of credit, but it does not remove the need to consider whether the term and instalment suit your needs. A loan with a lower TAEG but a much longer term could still result in a higher total amount of interest. Consider two hypothetical loans. Loan A: 20,000 euros, term 3 years, TAEG 7%.

Loan B: 20,000 euros, term 8 years, TAEG 6%. B has the lower TAEG and therefore a lower relative annual cost. But the debt remains outstanding for much longer. It is therefore possible that, in terms of total euros paid, the longer loan generates more interest. There is no contradiction. TAEG answers the question: “How expensive is this credit each year, including charges?” The total amount repayable answers a different question: “How many euros will I pay overall?” Both figures are needed.

TAEG and mortgages

For mortgages too, the nominal rate must be distinguished from the overall cost of the transaction. The Bank of Italy notes in its materials that, besides interest, buying a property with a mortgage may involve costs such as processing fees, valuation fees, insurance and other expenses connected with the loan. The economic principle remains the same: do not compare two mortgages solely on the basis of TAN. If one bank offers a slightly lower rate but applies much higher upfront charges, the difference may shrink or even reverse in the overall comparison. For mortgages, the term, type of rate, potential variability and early repayment options are also particularly important. TAEG remains useful, but must be read alongside the contract's features. Consider a simple example. Bank A:

• TAN 5%;
• upfront costs of 1,500 euros.

Bank B:

• TAN 5.4%;
• upfront costs of 200 euros.

If we looked only at TAN, we would choose A. But for a relatively small or short-term loan, the 1,300-euro difference in upfront charges could be significant enough to make B cheaper overall. This is exactly the kind of difference TAEG seeks to summarise. That is why the Bank of Italy describes it as particularly useful for comparing providers. Credit marketing often uses the instalment as its main selling point. “Only 99 euros a month” is much more intuitive than “TAEG 11.3%”. But a small payment may reflect a very long term. Suppose you are buying an item costing 10,000 euros. Paying 200 euros a month may seem more attractive than paying 350, but if the first plan runs for many more years, the final cost can become substantially higher. Before assessing the instalment, always check how many payments are required. A low instalment is not a discount. It may simply mean longer-lasting debt.

TAEG does not measure instalment affordability

This is another fundamental point. A loan with a low TAEG may be economically attractive compared with other offers, but still place too much strain on your income. Suppose a mortgage has excellent terms but requires a payment of 1,500 euros against net household income of 2,500 euros. The problem is not the price of credit. It is financial affordability. Two concepts must therefore be kept separate:

A loan may be inexpensive but unaffordable, or relatively expensive but have a manageable instalment. Naturally, the aim should be to achieve both: a reasonable cost and affordability.

Early repayment: the future cost can change

A loan may also be repaid before maturity. In that case, some future interest is not incurred, and consumer credit legislation grants consumers specific rights in the event of early repayment. This means the actual cost incurred may differ from the theoretical cost envisaged at the outset if the loan is closed early. But when signing, you should not base the entire assessment of value on the assumption that you will repay it in the future unless you are reasonably certain you can do so. TAEG is used to compare the terms set out in the contract at the time of signing.

TAEG and the usury threshold rate are not the same thing

Another common source of confusion concerns anti-usury legislation. TAEG is an indicator used to represent the overall cost of credit to the consumer. Checking for usury, however, follows specific statutory rules and uses its own indicators and methodologies, linked to the average overall effective rates recorded for different categories of transaction. You should therefore not automatically compare any advertised TAEG with a threshold rate and immediately conclude that a contract is or is not usurious. Both concern the cost of credit, but they are technically different areas.

What to look at before signing

A very simple method is to avoid choosing a loan on the basis of a single figure. For each offer, it is useful to write down at least:

Once these figures are placed side by side, many offers that initially seemed attractive become much easier to interpret.

Conclusion

TAEG is one of the most useful indicators when choosing a loan because it allows you to look beyond the interest rate alone. TAN mainly indicates the nominal cost of interest. TAEG, by contrast, seeks to represent the total cost of credit on an annual basis, including the other relevant charges specified by the rules. This is why a loan with a lower TAN may cost more than one with a higher TAN. A lower instalment may simply result from a longer term. And even a loan advertised as “zero interest” may have a positive effective cost if compulsory fees apply. The right question should therefore not be: “What is the rate?” Nor should it be only:

“How much do I pay each month?” It should be: “What is the overall cost of obtaining this credit, how long will I have to pay for it, and does the instalment remain affordable within my budget?” TAEG mainly answers the first part of that question. That is precisely why, when comparing two loans that are genuine alternatives, it should be one of the first figures you look at.

Note: the numerical examples are simplified and are for explanatory purposes only. The actual cost of a loan depends on the contractual terms, its duration, the charges applied and the repayment arrangements.