APR is the official rate used to help you understand the cost of borrowing
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If you’re looking to borrow money in the UK, using anything from a mortgage or remortgage to an unsecured loan or secured loan, you’re absolutely certain to come across the term ‘APR’. But what exactly does it mean and why is it important to understand it?
APR stands for Annual Percentage Rate. It’s the annual rate charged for borrowing money. The APR on a credit product represents the amount of interest that you’ll pay annually for the amount borrowed and includes all compulsory fees.
Annual Percentage Rates were introduced in the UK by the Consumer Credit Act (1974 and amended in 2006). An APR is worked out using a formula that was set to make lenders include all the elements of purchasing credit in the first year, including arrangement fees, set up costs as well as the interest.
What’s the formula for working out APR?
- Take the amount of your loan and how much interest you’ll be charged over one year.
- Divide that interest amount by the amount of your loan.
- Multiply the number by 100 and you get the APR.
For example, let’s say you borrow £1,000 and you’re charged £80 in interest for that year. The APR calculation would be:
80/1000 x 100 = 0.08 x 100 = 8%
Along with the APR, it’s best to also check the total amount you’ll be paying back.
What does Representative APR mean?
If you’re looking at adverts or examples of loans, you’ll notice that it will say ‘Representative APR’. To be representative, it must be the rate offered to at least 51% of the people that apply for a loan on that particular product with that lender. However, you’re not guaranteed to get this rate and means that just under half the people who apply will be offered a rate that’s higher than the APR that’s advertised.
Let’s take a look at an example of a secured, homeowner loan:
Annual Interest Rate 13.1% fixed, Representative 13.9% APR, based on borrowing £16,416 over 84 monthly repayments of £299.41, total amount repayable £25,150.44.
As you can see, the annual interest rate is 13.1% and this rate is fixed, so it won’t go up or down for the entire duration of the loan. It has a representative APR of 13.9%, so we know that at least 51% of the people offered this loan will get this particular rate. Along with the APR, ‘the total amount payable’ (in this case £25,150.44) is extremely useful when comparing loans.
APR for credit cards
Although calculating an APR is fairly straightforward for a personal loan, it can become complicated when you work out credit card borrowing because the use of a credit card can vary so much. Assumptions are made on how much of the credit card debt is outstanding, how much will be repaid each month and when in the month the repayment will be made.
Each credit card company makes its own assumptions on usage and there’s no standard model formula set out by the Consumer Credit Act for credit cards. Because of this, Annual Percentage Rates quoted by credit card companies can only be used as a rough guide, as the way you decide to use your credit card may produce a different cost of credit, either much lower or higher, depending on many factors than the example that the credit card company uses.
What does 0% APR mean?
With 0% APR credit, it means that there’s no interest or other charge for being offered on a loan.
Any credit offered with 0% APR can represent an excellent deal for the borrower. It’s typically offered as a special offer to attract borrowers to sign up for some form of credit. For example, a credit card company may offer 0% on purchases for a set period as an introductory offer and then revert to a variable APR. 0% APR can be especially useful for a borrower who needs access to a line of credit but doesn’t want interest being added to the balance straightaway, perhaps to give them some breathing space if they’re going through a particularly expensive period.
You may see 0% deals being offered on expensive items such as cars – especially if the car industry isn’t doing so well, or by furniture dealers wanting to secure a large number of sales in a short period. Be cautious though, as sometimes goods are offered at 0% APR but the price has been inflated to start with so that it’s more expensive than it really should be!
What is variable APR?
Just as it sounds, a variable APR can vary (change) whenever the lender wants to move the rate up or down, as the APR is not fixed.
What does fixed APR mean?
A fixed APR means that the rate you’re offered will be exactly the same for the entire length of the repayment period, no matter what happens. So, if the Bank of England decides to increase the base rate, the lender can’t just decide to increase their APR as well.
APRs and mortgages
Mortgages are more complex than unsecured loans or credit cards and there are often variables that can lead to a fairly misleading rate being shown.
For example, the APR should take account of any initial fees such as mortgage indemnity premiums, valuation fees and any arrangement or booking fees. But, it’s possible for lenders to avoid including the mortgage indemnity premium in their calculation by assuming a low loan to value ratio. So, if you applied for a 95% mortgage, the true APR rate in your case could be higher than that quoted in a rate comparison table. Also, valuation fees are usually worked out on a sliding scale, with a higher valuation fee for more expensive properties and a lower fee for lower-priced homes.
Things get even more complicated when you try to work out the APR for a discounted, fixed or capped rate mortgage – especially if your particular mortgage can involve a combination of these features. The fixed or discounted rate will probably last for just the first few years. Although you might assume that the APR calculation would take into account the introductory rate and then take into account the standard variable rate but this isn’t always the case. So, APR figures with mortgages can be quite confusing. That’s why it can be so important to seek advice from a mortgage broker such as Loan.co.uk.
What’s a personal APR?
A lender will calculate the APR they can offer to a borrower based on their individual circumstances, the length of the loan and the amount they want to borrow. To be able to work out this figure, the borrower will need to submit a full application for the loan.
An APR is worked out using a number of factors, including:
- The interest rate
- The frequency of repayments (daily, weekly, monthly or annually)
- Initial fees (sometimes applicable to a loan, either from the lender or broker) or compulsory fees that will need to be paid as a condition for taking out the credit
- Your credit history and credit score. If you’ve missed or made late repayments on loans for credit cards, lenders may assume that lending you money could be risky so the personal APR you’re offered may be higher than the representative APR.
Why the APR is important for borrowers
Because all loans have to display the APR, it makes it easier for borrowers to compare products when they’re looking for the best deal as the APR includes any additional costs as well as the interest rate.