APR – What does it really mean?
Published: 14 December 2007
By MoneyhighStreet Staff Leave a Comment
Updated: 4 October 2009
If you are taking out any form of credit, whether you are applying for a loan, credit card or getting a mortgage, the first thing you will look at is the APR of the loan.
What does APR really mean? And does it give a true reflection of the cost of the loan? We provide some answers.
APR stands for Annual Percentage Rate, and under the Consumer Act 1974 it is required to be published for all regulated loans so consumers can quickly and easily compare products.
When advertising any form of credit, the lender must ensure that the APR is more prominent than any other rate.
APR was introduced to enable consumers to compare different loans on the same basis so they could more easily tell which was the cheapest loan for them.
A basic interest rate a lender charges for credit does not accurately reflect the total cost of the loan to the borrower.
There are a number of reasons for this.
On top of the interest rate, there are other costs to consider such as
- administration costs
- acceptance fees
- broker fees and so on.
It would be next to impossible for consumers to individually consider these and then try and compare costs across different loans.
Because an APR takes in all of these extra costs, it will always be higher than the lender’s actual interest rate.
Another factor that affects the true cost of a loan is how the lender charges the interest and the time of repayment. These can vary and can affect the cost of the loan significantly.
Again, APR means that consumers do not have to worry about comparing these factors. The Total Charge for Credit Regulations specify exactly how lenders should calculate APR, so there is no discrepancy between them. The mathematical formula for calculating APR is very complex and beyond the scope of this article.
It is important to bear in mind that unless the loan is fixed, there is no guarantee that the APR won’t change during the duration of the loan. For example, if the Bank of England raises its interest rates, the APR on your credit card will also go up. On the other hand, you will benefit if the Bank cuts its rates.
If you have a fixed rate loan or mortgage, the APR cannot change during the fixed period.
When shopping for credit check you could compare loans from different providers to find the product with the lowest APR.
Howver whilst this is great and gets you in the right area, you need to do a bit more to make sure you have found the best loan deal.
One of the most common pitfalls on loans, mortgages and credit cards is low introductory rates. These are always attractive but can be deceiving. In order to assess the full cost of a loan you need to make sure you factor in such rates. If using a loan broker they will cover this with you.
Be aware that many loans, especially larger loans like mortgages, remortgages and secured loans can have expensive set up fees, perhaps a £1,000, that will not be written into the APR.
Also, many forms of credit come with their own set of restrictions, fees, charges and penalties – for example an early redemption penalty if you repay a loan within a defined period. These vary from product to product – be sure you check and understand any such restrictions.
As a general rule, if you keep up with repayments and settle the loan in the agreed term these will not be a factor. However, if you miss repayments, want to settle early, or deviate in any way from the original agreement it could end up being very expensive.
When taking out a loan or applying for any form of credit it may be worth considering Payment Protection Insurance or PPI.
This is basically insurance that will cover your monthly credit repayments if you cannot work as a result of being made redundant, being sick or having an accident.
Payment Protection Insurance does not have to be linked directly with the loan and there are independent providers who offer good PPI products at competitive prices.