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What does APR mean?

What does APR mean?

The annual percentage rate - or APR - is the total cost of borrowing money over the course of a year. It includes the cost of the interest rate as well as any fees that are automatically added to the loan, for example, arrangement fees. Knowing what the APR is can help you compare the costs of taking out a personal loan or credit card.

Anelda Knoesen
From the Money team
7
minute read
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Posted 01 JULY 2020

What is APR used for?

APR is used for a range of financial products including mortgages, loans, credit cards and car financing. The benefit of APR is that it gives you the true cost of borrowing, allowing you to make a fair and accurate comparison of different types of credit on offer. Here, we look at how APR works with loans.

Different loan providers may calculate interest in different ways - some might do it daily, others weekly, monthly or annually – making it hard to see which is the cheapest. So, loan providers are required to tell customers the APR to allow customers to compare loans more easily.

Loans, interest and APR: how they work together

If you take out a loan, you’ll need to pay interest on it.  The interest charged depends on:

  • how much you want to borrow
  • how long you want to borrow the money for
  • your individual circumstances, including your credit score.

For example, if you want to borrow £1,000 for one year and the interest rate is 5%, you’ll have to pay back £50 in interest (5% of £1,000) plus the £1,000 you borrowed – a total of £1,050.

Lenders generally calculate loans so that you pay the same amount every month over the course of your loan (even though the balance of what you owe is reducing), meaning the interest cost is spread evenly across the loan. This is different from credit cards, where the interest is calculated every month.

The APR is typically added to your debt on a monthly basis. To find the monthly interest rate, divide the APR by 12. The monthly rate on a 6% APR is 0.5%. This can help you compare loan rates with a monthly credit card rate.

So, for example, while interest on a loan might be 5%, the APR might be 8% because it includes other charges, such as set-up fees.

The length of time you borrow for will also affect how much you have to pay overall. The quicker you can pay off your loan, the less you will generally pay in interest. Here you can see the impact of both different APRs and different loan terms on borrowing the same amount of money.

Amount borrowed Interest rate APR Loan term Monthly payment Total interest paid Total paid
£10,000 5% 1 £855.57 £266.79 £10,266.79
£10,000 5% 3 £299.21 £771.58 £10,771.58
£10,000 5% 5 £188.20 £1,292.24 £11,292.24
£10,000 5% 10 £105.52 £2,662.82 £12,662.82
£10,000 15% 1 £898.14 £777.72 £10,772.72
£10,000 15% 3 £342.06 £2,314.07 £12,314.07
£10,000 15% 5 £232.98 £3,978.97 £13,978.97
£10,000 15% 10 £155.61 £8,673.77 £18,673.77

What is representative APR?

Lenders are required to tell you about representative or typical APR when they advertise a loan. Where the term representative APR is used, this advertised rate must be offered to at least 51% of successful applicants. But that rate may not be available to the other 49% of applicants, most of whom are likely to be offered a higher rate. The APR you’re actually offered is the ‘real’ APR – the interest rate you’ll have to pay if you take out the loan. If you have a poor credit history, you might be offered a much higher APR than the representative APR.

APR is a useful benchmark for comparing loans – it’s a legal requirement that it’s shown. Generally speaking, a low APR indicates lower interest rates and low associated fees. But while APR is good for making comparisons, it’s vital you look at every aspect of the loan before committing.

What is variable APR?

Whereas a fixed APR will stay the same, so you know exactly how much you need to pay back, a variable APR can change over the course of a loan. While there are several reasons why variable APRs change, many track the Bank of England interest rate and go up or down accordingly. Variable APRs are commonly used for credit cards.

What affects APR?

The business of providing loans is a competitive one and loan providers are therefore looking to attract customers with their best rates. But getting a low APR is influenced by:

  • your credit record
  • the amount you want to borrow
  • the length of time you want to borrow for – the loan term.

Typically, the better your credit score the lower the rate you’ll be offered; the worse your credit score, the higher the rate.

When deciding whether or not to offer you a loan, as well as considering what APR to offer, lenders are required to look at affordability for customers. This means that when you apply, they must consider whether you’ll be able to make the repayments as required and on time. They may also consider what other debt you have and how much of the credit available to you – your credit utilisation ratio - you’re using.

How to get a low APR loan

Your credit record

To get a loan at the lowest APR, you’ll need a very good credit history. If your credit history is damaged or you haven’t borrowed before, you may find that you have to pay more.

You can check your credit score for free with the main credit reference agencies:

  • Experian
  • Equifax  
  • TransUnion

The amount you borrow

Generally, the more you borrow, the lower the rate you’ll see quoted. For example:

Initial loan APR APR cost Total repayment
£3,000 9% £270 £3,270
£7,000 6% £420 £7,420

However, you should only borrow the amount you can afford to pay back.

The length of time you borrow for

Another way of lowering your payments is by extending the term of your loan. This will drive down your monthly repayments and mean you pay less over the course of the year. See the difference in monthly repayments in this example, but also the total cost of the loan.

Loan Loan period APR Monthly payment
£6,000 3 years 9%  £189.82
£6,000 7 years 9% £95.47

Borrowing for longer means you end up paying out more in the long run, so be careful and don't be seduced by lower rates over a longer period. The golden rule of borrowing is to borrow as little as possible and pay it back as quickly as possible.

Even with a low APR, borrowing should always be carefully budgeted for. You don’t want to put yourself under unnecessary financial strain in the future.

APR for unsecured loans vs APRC for mortgages and secured loans

APRC is used to compare mortgages and other loans that are secured against an asset, your house, for example. APRC stands for annual percentage rate of charge. It’s designed to show you, as a percentage, the annual cost of a loan, including fees and other costs, if you keep your mortgage or homeowner loan for the full term. 

The APRC assumes you keep the same mortgage product and provider for the whole length of the mortgage (usually 25 years) and that interest rates don't change. This can make it of limited use when comparing mortgage deals as most people won't stay with the same provider. People move home and many borrowers compare deals when their fixed term comes to an end and remortgage to a better deal. If you’re going to be an active switcher, the initial rate might be of more importance to you. 

Homeowner loans – loans that are secured against your home – will show their interest rate as an APRC. It's a handy reminder to help you see the difference between a secured loan and an unsecured loan, which will show the interest rate as an APR. You can compare mortgages and compare remortgages with Compare the Market.

How do I find out my personal loan rate?

When you apply for a loan, you might not be able to find out whether you’ll be accepted or what rate you could be offered until you’ve been through the application process.

Every time you make a loan application, a hard credit check is recorded on your credit file. Whether or not you were accepted isn’t visible to a lender. However, if lenders see multiple applications from you in a short period of time, it could raise a red flag and mean you may not be accepted for a loan or you’ll receive a higher APR.  

Ideally, you should only apply for loans you’re confident of being accepted for. Most lenders have personal loan eligibility calculators that let you calculate your personal loan rate without it affecting your credit score.

Finding the right loan for you

We’re here to make things as straightforward as possible. When it comes to comparing loans, we’ll make it clear what the APRs are, what you need to pay each month and overall. Compare loans to find a deal to suit you.

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