Navigating the world of UK consumer finance can sometimes feel like a bit of a minefield. With so many acronyms and financial jargon to sift through, it’s no wonder people can feel overwhelmed when looking at loans, credit cards, or mortgages. One of the most misunderstood financial concepts out there today is APR, or Annual Percentage Rate.
If APR is a bit of a mystery to you, don’t worry. In this guide, we’ll explain exactly what APR is and give you all the info you need about how it applies to your finances. Let’s get started.
The basics: what exactly is APR?
In a nutshell, APR — Annual Percentage Rate — is the measurement by which consumers can judge exactly how much financial products will cost them in the long term. These products could be credit cards, mortgages, loans, and other forms of lending.
Though APR is easily confused with an interest rate, the two are different, because APR is the total cost of the borrowing, including not just the interest rate, but also any admin fees charged by the lender. APR is a quick way for a potential borrower to understand exactly how much the borrowing would cost in total over a single year. For example, if you were to borrow £1000 with 6% APR, you would pay back a total of £1060.
The two flavours of APR: fixed vs. variable
When you’re making lending decisions, you’ll often see two different options when it comes to APR: fixed and variable. Simply put, a fixed APR means that the rate will not change from year-to-year over the duration of the lending period.
Conversely, a variable APR means that the rate you pay on the borrowing could potentially change as new years roll around. While this may sound concerning, it’s important to note that most lenders use a fixed APR, and those that don’t are required to provide notice in writing to borrowers.
There are also regulations governing how much a variable APR can change during the lending term, so you don’t need to worry about a jump from 6% to 60%, for example. If you have questions, be sure to raise them with the lender before committing to borrow.
What does “representative” APR mean?
Because everyone who applies for a credit-based product has a different credit history, each will be offered a slightly different rate for the borrowing.
For this reason, it’s very difficult to give a single APR figure which applies to everyone. To solve this, lenders use representative APR, which is simply the rate which they provide to 51% of their customers. This calculation is set out specifically by law so that consumers can make an informed decision.
By way of example, imagine that you’re applying for a credit card that offers a representative APR of 17.9%. This simply means that 51% of people were offered this rate – but the remaining 49% were offered a different rate (usually a higher one). To make your borrowing decision easier, most lenders are required to provide an example of the cost for the representative rate.
What factors affect the calculation of APR?
As explained above, the Annual Percentage Rate is not just the interest rate for the borrowing – it includes other costs too. Most commonly, these costs are things like the annual fee for a certain account or credit card. In such cases, you’ll see a much higher rate because the fee will be included in the calculation along with the interest rate.
The other factor which plays a major role in the APR you’ll be offered is your credit rating and credit history. Lenders need to manage risk, and they do this by considering affordability and setting rates accordingly.
As mentioned, representative APR is the rate given to 51% of successful applicants, but it’s possible that you will be given a higher rate, too. All lenders will refer to your credit history to make a decision about a rate they feel is affordable and appropriate based on your credit score.
Another factor that is worth bearing in mind when thinking about APR is whether the lending is secured or unsecured (i.e. whether it’s been secured against an asset such as property). Lenders are far more likely to offer a low rate if they know that the lending is secured in this way. Of course, if you’re not comfortable with the APR you’re offered for a particular product, you’re free to refuse it before committing to the borrowing.
We hope this guide has given you the information you need to make a more informed decision about borrowing. APR can be something of a nebulous topic if you’re not sure what it represents, so having an understanding of the rate before you start applying for loans, credit cards, or mortgages will be a powerful tool in getting the best rate for you.