Site Search:

Home Loans Debt Management Mortgages Calculate Repayments Loans FAQs Loan Options
Bad Debt Loans Secured Loan APR guide What is APR PPI Fixed Rate Extra Borrowing Info
Business Loan Home Improvements Interest Rates Conservatorys Xmas Credit

What is APR, and why does it differ from the interest rate.

Find out about APR. What APR means - and why it differs from the interest rate

You might have seen the term "APR" banded about in the small print of many companies who are offering you credit - like catalogues and loans, for example. But what on earth is this APR thing. That's what I'm going to try and describe now - what is APR.

The basics

OK, to start with, APR stands for Annual Percentage Rate. The APR rate isn't just the interest rate applied to a loan; but also includes any fees and charges too. The APR for credit always has to be shown, with the idea that you can easily compare the cost to you of one loan or credit against another.

Tell me more

Right then, let's look at a standard loan. We'll make a few assumptions for this example. First of all we'll assume the loan is for 1 year. We'll also assume the interest rate on the loan is 10% (not necessarily the APR - we'll come back to that...). Now let's say we want to borrow £1,000, and there's no other fees. The total amount you pay is £1,100 (which is the £1,000 loan + 10% interest). In this case the APR is 10%; the same as the interest rate.

OK so far? Now let's add a fee in. The figures will stay the same as before: £1,000 loan. 10% interest rate. One year repayment period. The total interest payable is £100, as before (which is £1,000 x 10%). But on top of this you've got a £100 "setup fee". So now we're paying back £200 in charges (£100 in interest and £100 in set-up fees). The APR would be worked out as the loan amount, divided by the total interest payable plus the fees. Let me show the example:

(£1,000 loan) / (£100 interest + £100 charges) = 0.20

For completeness, we'll multiply the answer by 100:

0.20 x 100 - 20%

So the APR is 20%. While the interest rate is 10%. This is why a cheaper interest rate isn't always a cheaper loan!

The last bit

Hopefully this has cleared things up a little. APRs get a tad more confusing for short term, or "pay day" loans - but we'll cover that in a later instalment.

Social networking
Like us on Facebook