APR stands for ‘Annual Percentage Rate’ and it’s used to as a way to allow people to compare the cost of different loans side by side. It shows the true cost of the money borrowed and reflects this as an annual rate – ie how much you’ll pay per calendar year. All lenders use the same formula to calculate APR and this makes it easy for customers to do a direct cost comparison between different lending products.
The term APR has a legal significance. It is calculated using a complex formula that is prescribed by the Consumer Credit Act (1974).
The APR calculation needs to include all the costs of borrowing, this includes:-
• The interest rate
• When interest is charged (daily, weekly, monthly or yearly)
• Initial documentation fees or file charges (as some lenders charge a set-up fee when a loan is arranged)
• Any other costs applicable to the loan (including fees a broker may have charged)
An APR is important because it prevents lenders from hiding any additional costs and ensures you get a true cost of the borrowing when considering a product.
For example:
Lender A offers a loan with an interest rate of 13.6% p.a. plus an arrangement fee of £200
Lender B offers a deal with a rate of 15.2% p.a. and arrangement fee of £50.
Without an APR, it is very difficult to work out which of these two deals is cheaper. The first has a cheaper interest rate but high fees and the second a higher interest rate but a small arrangement fee.
So the loan with the higher interest rate may be cheaper than the one with the lower rate because of the arrangement costs. The APR takes this into account so you know that you are comparing.
Carefully borrow money and ask the lender if there are any other fees payable and in turn if they’re included in the APR calculation. Be sure not to get confused between APR and Interest rate. When you are quoted a figure over the phone, be sure to confirm if that’s APR or just the interest rate. The APR will always be higher.
The APR will not include any non-standard costs, so any late payment fees are not taken into account. Ask lender about non-standard costs and reason yourself to see that you are comfortable with these. Similarly, any early settlement charges will not be included.
When APR figures are quoted on promotional material, they will be accompanied by the term ‘representative APR’, this is because stating the APR is a legal requirement, and the rate stated must be that which is offered to at least fifty percent of the loan applicants that get approved for that loan, hence making it the representative rate offered.