In one sentenceThe annual rate that reflects the true cost of financing, after accounting for gradual repayment and fees, used to compare financing offers.
Simply put
An offer advertising “4% flat” calculates the rate on the full amount for the whole period, even though you repay part of it every month. The annual percentage rate calculates the cost on what you actually still owe, so it comes out higher.
When comparing two offers, compare the annual percentage rate, not the advertised rate, because it combines the installments and fees into one comparable figure.
Worked example
Equipment financing of 80,000 SAR at a flat rate of 4% a year for 60 months with no fees, as in the example in the “Finance, cash, or lease?” tool.
Monthly installment80,000 × (1 + 4% × 5) ÷ 60 = 1,600 SAR
Total repaid1,600 × 60 = 96,000 SAR
Advertised rate4% flat
Effective annual percentage rate7.42%
Formula: The monthly rate at which the present value of the installments equals the net financing amount × 12
Don't confuse it with
Simple interestThe advertised flat rate is simple interest on the original amount, and the annual percentage rate converts it into an actual cost on the declining balance.