What is APR?
Introduction
Most consumers, nowadays, are familiar with borrowing money, whether on a mortgage loan, personal loan, credit card, or some other form of credit agreement, and repaying that money, with interest, over a period of time. There are, however, numerous other components including acceptance, arrangement or administration fees, insurance, etc. which may affect the cost of borrowing, but which may not be altogether obvious. This is why APR, or "Annual Percentage Rate", is such a useful figure for borrowers. APR describes the true cost of borrowing, over a year, and includes not only the interest rate that you must pay, but also takes into account the manner in which you repay the debt. The frequency and amount of repayments and the repayment term, any fees or charges and premiums for PPI ("Payment Protection Insurance"), if this is compulsory, are also taken into account
APR Considerations
Essentially, APR is a measure of how much a loan, or other credit agreement costs in interest annually expressed as a percentage of the total amount that you borrow. So, for example, if you borrow £1,000 for one calendar year, and are charged £80 in interest during that period, the APR can be calculated as 80/1000 x 100 = 0.08 x 100 = 8% The calculation may actually be more usefully performed the other way around, so that if you borrow £1,000 for a year at 8% APR, you can see that it costs you £80 in interest.
Lenders are legally bound by the Consumer Credit Act 1974 to include the APR in any credit agreement and to display a "typical" APR in most advertisements. APR obviously varies from lender to lender and from product to product, so banks credit card companies etc. must clearly illustrate their own APR. The borrowers can then compare one product with another. Generally speaking, not withstanding any charges that may not be included in the APR, the lower the APR, the lower the cost of borrowing. It pays to shop around for the most competitive deal.
Do bear in mind, however, that lenders are permitted to advertise interest rates monthly rather than annually, so you may see interest rates as low as 2%, or 3%, per month, but must still reveal their actual APR before any credit agreement is signed. A monthly interest rate of 2%, or 3%, actually equates to an APR of 24%, or 36%, and given that a typical APR for a credit card is 17.5%, or thereabouts, it is not too difficult to see why a lender might want to advertise monthly interest rates initially. Bear in mind too that an APR referred to as "typical", or "illustrative", used for advertisement purposes, may not be the rate offered to all borrowers. It must be applicable to 66% or more of applicants in order to be advertised as such.
Lenders typically investigate the financial status, employment status, and credit history of prospective borrowers. Usually they involve a credit reference agency such as Experian or Equifax in order to determine the eligibility of a borrower for credit in the first place and the amount and APR that he or she can be offered. The APR of any credit agreement must be confirmed and quoted to a borrower before that agreement is signed. It may be beneficial to obtain a copy of your credit history and credit rating for yourself so that you can check that it is correct, and that you are being offered an APR commensurate with your credit rating.
Borrowers should, however, also ask their own questions regarding charges, if any, not included in the "headline" APR of any credit agreement. PPI, or "Payment Protection Insurance" is one such charge that a lender may or may not deem to be compulsory for the acceptance of a loan or credit card agreement. PPI has been the subject of much miss-selling over the years and has recently been investigated by the FSA ("Financial Services Authority"). As a result, make sure that for this or any other additional charge, you understand what the charge is, whether you need the service being charged for, and when you need to pay. You may also like top ask a lender if a credit agreement is subject to penalty and/or administration charges which is typically £15 or more, for late payments, etc. and what those penalty charges are. This is because penalty charges are not quoted in any APR, but added to the total outstanding balance on which interest is charged.