Loans and APR: what you need to know

APRs have long been used to demonstrate the cost of borrowing. But are they the most accurate measurement? We take you through APRs, interest rates and how you should use them when choosing a loan.

Caroline Ramsey Published on 21 September 2018. Last updated on 14 September 2021.
Loans and APR: what you need to know

When you start looking around for your personal loan, you’ll notice that most advertise their ‘APR’. This is a standard measurement intended to help consumers compare financial products.

It is a useful indicator of how much a loan will cost but, depending on the type of loan you are looking to take out, it’s not always the best way to check if you are getting a great deal.

Here, we look at understanding APRs and why they are not always as useful as they seem.

What is APR?

APR stands for Annual Percentage Rate and is used to illustrate how much it costs to borrow over the course of one year and includes any fees plus the interest charged.

UK regulation dictates a standard set of principles for how APR must be calculated to ensure it can be used as a fair comparison between products. Whilst the Interest Rate looks like a similar number there are a few ways in which it can be applied which will result in the product costing you more or less. This includes: what period that interest applies for as it may not be one year, when the interest is added to the balance, how repayments are treated.

APRs must be made available by lenders before you sign on the dotted line to take out a personal loan.

It is also not just the application of the interest rate that determines the cost to a consumer - a product’s fees can also be a significant cost. The APR includes the fees to ensure the comparison will be fair between products charging different levels of fees.

APRs must be made available by lenders before you sign on the dotted line to take out a personal loan. The Financial Conduct Authority, which regulates the industry, says that the APR is intended as a tool to help consumers compare financial products.

How to calculate APR

To work out the APR you have to calculate the total interest charge and add any fees and then work this back into an annual interest rate which would result in the same cost. Thankfully, you never have to work this out as lenders are required to work it out and show it prominently wherever they promote their product.

What does a ‘representative’ APR mean?

It is an additional regulatory requirement that loan providers will also provide a “Representative APR”. The Representative APR is the APR that a firm reasonably expects that 51% of its applicants to achieve.

It means that at least 51% of applicants will be offered this rate, while 49% could, in theory, be offered a higher rate. The actual APR you are offered can vary due to your individual circumstances such as your credit history, history with lender, how much and how long you want to borrow the money for.

APRs and short-term personal loans

Using an APR to compare short-term loan products is particularly unhelpful.

Due to APRs being there to provide a view of cost over the course of one year, using the same tool for short term loans is not particularly helpful in understanding what the loan is really going to cost you.

Short-term loans are loan products usually designed for borrowing smaller sums of money and tend to be taken out over a term less than one year. The loan is often repaid over a number of instalments, like a regular personal loan, but can have a term of just a few months.

They are often used to cover unexpected costs, ease financial pressures or pay for essential repairs. They offer a solution over a short term, so long as you are confident you can meet your repayments. Short term loans are often available to those with poor credit ratings who need quick access to funds. But they are subject to much higher interest rates, and can lead to further debt problems if you struggle to pay it back.

To provide a clearer view on the cost of borrowing a short term loan, recognising that APR was not as helpful for loans under a year, the FCA introduced Total Amount Payable (TAP). Total amount payable is the actual amount you are paying during the loan term. It is a total of all the monthly installments paid during the loan period.

Reasons for differing APRs

There are a number of factors to consider when trying to understand the full cost of taking out a loan.

  • The term of the loan: The APR advertised for a loan will apply to loans taken out over a certain term. If the loan you require is for a longer or shorter term, the APR is likely to be different.
  • The amount of the loan: The same applies to the amount as it does the term. If you want to borrow more or less than the advertised loan, its likely the APR will be different.
  • Your credit history: Your credit history will play a part in the final APR you are offered. If you have a less than perfect credit history, you will most likely be offered a higher interest rate than advertised.
  • Understanding fees: Make sure you fully understand how your APR is made up. If there are fee’s bumping up that APR, check out what they are, can you find a similar loan with lower or no charges?
  • Understanding charges: Early repayment fees are not included in APR calculations as it can only be calculated on the assumption you keep the loan for the full term. So find out what happens if you are able to clear the loan early – are there penalties?

Comparing loans

Understanding APR, Representative APR, how its calculated and how it can change, is a great start in finding the most suitable loan for your circumstances and giving you confidence to feel like you can find a great deal.

At NerdWallet we provide you with a comparison service to search for products, broken down into the different types of lending, catering for all borrowing needs and all types of borrowers, from those with excellent credit history to those will less than perfect ones.

About the author:

Caroline Ramsey is a content creator who specialises in personal finance. More than a decade of working in editorial teams, she offers highly tailored content covering a number of topics. Read more

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