The APR – the annual percentage rate charge – is the annual cost of credit paid by a borrower, expressed as a simple percentage. The concept was introduced in the Consumer Credit Act of 1974 to give customers a truer indication of the interest rate being applied to their loans.
What exactly is an APR?
The APR is a precise measure of the annual cost of borrowing. It takes into account the interest on the loan as well as other fees such as the arrangement fee.
How is it different from an interest rate?
Quite different. The APR is a complicated mathematical calculation. Say you borrowed £1,000 for one year and repaid it at £100 a month. At the end of the year you would have repaid £1,200. You’d be forgiven for thinking the annual interest rate was 20 per cent. But the amount you owe is reducing each month. Therefore, the £200 interest you repaid is a great deal more than 20 per cent of the money owed. In this example the APR is 41.3 per cent.
Are all APRs calculated the same way?
No, the methodology can vary from lender to lender. There may also be some charges not included in the APR, such as optional payment protection insurance.
Are there any regulations governing how lenders come up with their APRs?
No. But the Financial Services Authority requires all lenders to tell you their APR – and the charges included in the calculation – before you sign any loan agreement.
Is there a way I can figure out the APR on my own?
Many mortgage comparison websites have APR calculators for you to determine which loan appears better. Try the FSA’s calculator at: www.fsa.gov.uk/consumer/04_CREDIT_DEBT/loan_calculator.html
Is a higher APR always the worst deal?
Not necessarily. The level of APR charged on credit cards, for example, can depend on factors such as the length of the interest-free period (see example below). For this reason, credit cards with a relatively low APR can end up being more expensive than cards with higher APRs. The solution: treat APRs as a rough guide only. For a true comparison of costs look at monthly repayments.