APR Explained

APR stands for the Annual Percentage Rate of charge. You can use it to compare different credit and loan offers. The APR includes important factors such as:

the interest rate you must pay;
how you repay the loan; the length of the loan agreement (or term); frequency and timing of installment payments; and amount of each payment;
certain fees associated with the loan; and
premiums for payment protection insurance that the lender chooses to make compulsory.

All lenders have to tell you what their APR is before you sign an agreement. It will vary from lender to lender. Generally, the lower the APR the better the deal for you, so if you are thinking about borrowing, shop around.

Example 1:

If you borrow £1,000 for one year at 20% interest, and at the end of the year you repay a lump sum of £1,200: you will be paying an interest rate of 20%; and the APR will also be 20%.

Example 2:

If you borrow £1,000 for one year at 20% interest, and pay throughout the year in equal monthly instalments (12 x £100 = £1,200), you will still be paying an interest rate of 20%; but the APR, however, will be roughly 40%.

Example 2 is more expensive because you are paying back the £1,000 gradually throughout the year. In Example 1 you have the benefit of being able to access the £1,200 for the whole year, which you could invest and earn interest on. By paying in instalments you're losing out; this increases the cost of the loan - hence the higher APR.

Questions to ask the lender

If you find a deal with a low APR, ask the lender the following questions:

Does the interest included in the APR vary, or is the rate fixed?

If the rate is variable, your repayments could go up or go down. If the rate is fixed, your repayments will stay the same.

Are there any charges that are not included in the APR?

This could include charges for services such as optional payment protection insurance. If so, make sure you understand:

• what the charges are;
• whether you really need the services offered;
• how much you would have to pay; and
• when you would have to pay

What are the conditions of the loan or credit and do they suit you?

For example, do you have a choice about how and where you make the repayments? If you suddenly have spare money, can you pay the loan off early - without penalties?

Can you afford the monthly payments?

A more expensive loan (with a higher APR) could have lower monthly payments if they are spread out over a longer period of time. That might suit you better if your budget is tight, even though you would pay more in the long run.