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What is APR?

What is APR?

What is APR?

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Understanding APR is crucial if you are considering taking out any form of credit. Here, we explain what APR is and how it works.

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What is APR?

APR stands for Annual Percentage Rate. Lenders tell you the APR so you can better understand the overall cost of borrowing money from them over a year.

The APR does not just include the interest rate on a financial product, such as loan or credit card. It also takes into account other charges that you will be required to pay. All loan providers, including those who supply personal loans, must inform you of the APR before you borrow money from them.

When you are comparing loans (or other forms of credit), the APR is a good place to start.

What does 'representative' mean?

So what is representative APR? If you see the word ‘representative’ before APR, it means that not all applicants will get this rate. Only 51% of those who are approved for a loan must be given the representative APR. Others could get a higher rate. So your personal APR may be different to the APR advertised.

Representative APR example: A personal loan advertises its representative APR as 17%. Only 51% of those who are accepted for the loan have to get it at that rate. That means 49% of people may get a different rate, which is probably going to be higher.

How does APR work?

APR is expressed as a percentage. It enables you to see what a loan will cost you annually.

A good rule of thumb with interest rates is that the lower the APR, the less a loan should cost you. So normally, a loan with an APR of 5% should be cheaper than a loan with an APR of 9%. However, this is not always the case, so checking your terms and conditions before signing anything is vital.

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The difference between simple and compound interest

This is a really important distinction. The easiest way to explain it is with a savings account.

Simple interest is, for want of a better word, simple. Say you had £200 and you put it in a savings account with 10% simple interest. Here, you would earn £20 per year, every year, on your money.

However, with compound interest, you actually get interest on the interest. So, for the above example, in the first year you would still earn £20. However, in the second year, you now have £220 in your account and you would earn 10% interest on this. This would result in you earning £22 interest in the second year, taking your total pot to £242. And so on.

With borrowed money, the same rule applies. Say you borrowed £300 at 10% over 2 years without paying any of the money back. With simple interest, you would pay back £360. Compound interest means you would repay £363.

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How to calculate APR

APR is not just about the annual interest rate. APR is calculated taking into account any compulsory charges.

Legally, each loan provider must provide you with a representative APR. Many lenders have a calculator on their website, so you can see how much you could end up paying back over a certain time period, if you get the advertised representative APR.

If you are given a monthly interest rate, make sure you use an APR calculator to get a real comparison.

What are the different types of APR?

There may be difference between the APR that you will get (your personal APR) and the representative APR (also known as Typical APR).

It also worth noting here that when a credit card company advertises their representative APR, they are talking about the APR on purchases.

A cash withdrawal or balance transfer could carry a different amount of interest.

If you see credit advertised with an introductory APR, this means that this rate is for a limited time only. The APR will go up after a specified period of time.

You may also come across something called the periodic rate. This is the APR over a certain period of time. For example, a monthly periodic rate would be the APR divided by 12.

Finally, you may see credit advertised on a variable APR. A variable rate APR means that the interest rate changes following, for example, the Bank of England’s base rate.

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What is a good APR for a loan?

APR varies depending on both the company and the financial product.

Short-term loans, for example, generally have a higher APR than longer term loans. High Cost Short |Term Credit (often called Payday loans) can have Representative APRs of over 1,000%. A longer term loan from a high street bank could be as little as 5%.

The APR you are offered can be affected by your credit score. For example, if you have a poor credit history, you may find that you are offered a higher APR than the one advertised.

It always a good idea to research what different lenders are offering, before deciding on which loan is right for you.

What can I do to get the lowest APR?

A good credit rating may help you to get the lowest APR. This is because your credit score not only helps loan providers to decide whether to lend you money but can also determine what APR you will get.

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In addition, if you have a poor credit rating, your choice of loan providers may be more limited.

Is APR the most important thing to pay attention to?

APR is a very useful way to compare loans in a like-for-like manner.

However, it is always important to check what you will pay in real terms.

For example, payday loans often have extremely high APRs. While a longer term loan APR can look lower, in some instances it could end up costing more overall than a short-term loan. An APR is an annual rate. A 3-month short-term loan is not meant to be paid off over a year but over 3 months.

This is why it is important to always calculate exactly what a loan will cost you and not just rely on the APR.

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Summary

Understanding APR is essential in order to accurately compare loans.

While looking at the representative APR is a good starting point for your comparisons, it is important to remember that this may not be the APR that you are offered if you apply for the loan.

Your credit history can affect the rate of interest that a lender ultimately offers you.

As well as the APR, it is also important to calculate how much your loan will cost you in real terms. This way, you know exactly how much you will have to pay back overall and can ensure that you can afford the repayments.

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