Most people have heard of APR. Many people use it as one of the most important factors when deciding whether or not to take a loan. But how much do YOU really know about APR?
The likelihood is that you actually don’t know very much about APR, how it works and why it is used. This may not seem like an issue, but some may feel it is important to understand how interest rate calculations work if you are going to use them when borrowing credit.
Let’s start right at the beginning
Annual Percentage Rate is commonly abbreviated to the APR. The term shows the percentage rate of interest that you will pay over the course of a year on money you have borrowed.
APR is commonly used when you take out credit for products such as personal loans, credit cards, car finance etc. It is a simple way for you to compare various credit options to get the best rate.
Why is it important?
Simply put APR relates to the amount of interest that you will pay each year on the money that you have borrowed. Using APR allows you to compare a range of loans side by side allowing you to choose the most competitive option.
The biggest advantage of being provided with APR’s is that you are provided with an easy to understand figure that is likely to be important when determining whether or not to accept a loan rate.
When comparing APR’s you are looking for the lowest rate. Therefore 5.9% would mean that you pay less interest than if you had a rate of 7.9%.
When you are looking to borrow money it can become confusing as you might be provided with different types of rates such as flat rate and APR. APR was designed to provide consumers with an easy way to compare loans side by side.
APR is a fair way to compare loans as it will take into consideration the interest over the term of the loan, any set up costs, arrangement fees and final payments.
Why do APR rates differ so much?
There are a number of things that will affect the rate that you are offered. The main points will be:
Credit Score – Your credit rating will have a direct impact on the rate that you are offered. The better your credit rating, the lower the APR you will be offered. The difference between someone with and excellent credit rating and someone with a poor credit rating could be as much as 40 – 50%.
Term – The length of the agreement will effect the APR. Generally the longer the term of the agreement the more interest you will pay, therefore the APR will be higher.
Loan Amount – the amount you wish to borrow may also affect the APR that you are offered. Some lenders will reduce the APR if you borrow more money from them.
How is it calculated?
Mathematically APR is calculated by performing a number of calculations based upon trial and error. This is because the calculation cannot be reverse engineered. The most important elements are the total amount payable over the course of the loan and the monthly payments.
In the example below the loan is £100 over a period of 2 months. The total amount payable is £120.
The calculation is complicated. You can see the loan amount borrowed on the left (100), the monthly repayments spread by the term (120/2 = 60). The calculation below is where the trial and error is used to understand the level of APR.
We know that calculating the APR manually is difficult. This is why we provide a car finance calculator that you can use to change the APR and the loan amount to calculate your finance agreement.
Check you are comparing like for like
APR is a unique way of calculating the interest that is paid back on a loan. This makes it very hard to compare with other loan rates and percentages. This is why it is important that if you are comparing loans that you ensure you are quoting the figures of like for like products.
For example if you speak to a lender about a loan they may quote figures to you as a flat rate rather than an APR. If you have already had a loan offer as an APR figure the two rates will not be comparable.
If you have any doubt ensure that you ask the advisor for an APR level which will ensure that you can compare loans accurately, as the calculation was intended to be used.