What Is APR?

Published by Maku Seun on

What is APR? Find out below.

This is a bit technical. But APR means Annual Percentage Rate, and it’s the official rate used if you want to borrow. When it’s calculated it includes both the cost of the borrowing and any associated fees that are automatically included. This is meant to give you the overall equivalent cost of a debt.

What is APR?

This is from the regulator, the Financial Conduct Authority (FCA):

“APR stands for the Annual Percentage Rate of charge. You can use it to compare different credit and loan offers. The APR takes into account not just the interest on the loan but also other charges you have to pay, for example, any arrangement fee. All lenders have to tell you what their APR is before you sign an agreement. It will vary from lender to lender.”

The fact that it includes charges means sometimes the APR can be a bit confusing. It is possible the interest rate is 14% per annum, but the APR is 17%, as the impact of the charges adds the equivalent to another 3% interest.

Yet this is useful as it allows a true comparison.

Sometimes if a credit card company increase its interest rates, there will be a letter informing you of this in monthly terms.

This will make it look smaller, yet 2% monthly interest is a huge 27% APR.

This is because of compounding interests and is not as easy as multiplying 2 by 12 months.

You can see the formula used to calculate your interest rate.

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Interest Rate Converter Formula:

Monthly to Annual = ( (1 + Interest) ^ 12 ) – 1
Annual to Monthly = ( (1 + Interest) ^ (1/12) ) – 1

Problems with the APR rate

While this sounds good so far, there are a number of problems with APR. Here are three of the main things to watch for.

It doesn’t make sense with changing rates

The APR is meant to indicate the amount you will pay each year over the full term of the debt. Yet when rates change this can make it more rather than less complicated.

Mortgages are the best example. The APR is calculated by taking the total interest cost over the 25-year term of the mortgage, plus fees.

This figure must be included prominently in mortgage adverts and brochures.

Yet what does it mean practically? A mortgage could tout 6.6% APR, yet you may never be charged that percentage advertised; instead you get a 4.5% fixed rate for two years followed by 6.75% variable for the remainder of the term.

The 6.6% is the average cost if you were in the unlikely situation of keeping that mortgage for the full 25-year term, not a very useful figure.

APR

You won’t necessarily get the advertised APR

So far we’ve explained what APR means. However, where the term ‘representative APR’ is used, this means 51% of successful applicants will be given the advertised interest rate. The rest will most likely get a higher rate.

Credit cards

With credit cards, the rate for purchases (as opposed to balance transfers or cash withdrawals) is used as the main rate to advertise the card.

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So if that is described as 19.9% representative APR, then 51% of people accepted have to get 19.9% APR, but the other 49% could be offered a different rate (likely to be higher).

Personal loans

Loans are slightly simpler as they only have one rate. So if a loan is advertised as being 7.5% representative APR, this means 51% of accepted applicants have to get 7.5%, and up to 49% could be offered a different rate (likely to be higher).

Of course, some people will be rejected outright for the card or loan too.

Get a Loan

It only includes compulsory charges

Get a loan and some lenders will automatically include payment protection insurance in the quote.

Technically this is voluntary, but you usually need to opt out (and you should do – read the Cheap Loans article).

Yet while we're pushed to get the insurance, as it isn't compulsory, its cost isn't included in the Annual Percentage Rate.

Therefore some lenders deliberately load the cost of the insurance policies and make the loan rate cheaper.

This means that with payment protection insurance a 6.7% Annual Percentage Rate loan can cost more than a 8% APR loan, as the latter has much cheaper insurance


Maku Seun

Maku Seun is a blogger, an entrepreneur and author of Charge Your Life currently on Amazon. He has started various online businesses and is well experienced in saving and managing his money. Follow to get more money saving tips.

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