APRs: jargon myth busting

When you think about banks and borrowing money, many of us automatically think about all of the financial jargon that comes with it. When you need to borrow money, not knowing the difference between these terms can really cost you. So, what does it all mean?

What is APR?

An APR (annual percentage rate) is the annual cost of your loan expressed as a percentage and represents the yearly cost of your loan over its term. Importantly, it includes the standard fees and interest you’ll have to pay.

Let’s say you borrow £10,000 over 3 years to buy a car. An APR of 5.5% would include your annual interest rate as well as standard fees payable for the loan. You would then pay 36 monthly repayments of about £301, totalling £10,848.60.

This means you would repay the £10,000 you borrowed and an additional £848.60 in interest and fees.

Your repayments are the same every month because of how the interest is calculated. At the start of the loan term, your repayments will include more interest but less of the loan balance. Towards the end of the loan term, your repayments will include less interest but more of the loan balance.

What is a Representative APR?

Looking at APRs can help you compare lending products, such as loans or credit cards, on a like-for-like basis.

If you search for a loan on a price-comparison site, the different loan options are often ranked by the Representative APR. 

The key word here is ‘Representative’. When a loan is advertised with a Representative APR, it means that at least 51% of customers will receive a rate that is the same as, or lower than, the representative APR – although not everyone within the 51% will necessarily get the same rate.

It can be easy to assume that the lender advertising the lowest representative APR will give you the best rate. However, when you apply, it’s likely you’ll receive a personal APR based on your circumstances. This could be the same, higher, or lower than the representative APR.

It’s important, when looking at borrowing money, that you don’t assume you will receive the Representative APR advertised. Your personal offer could both be lower or higher than the Representative.

What’s a personal APR?

When you apply for a loan, it’s likely that the rate you receive will be based on your personal circumstances. It will take into account your credit history and current financial situation. The lender will also consider the amount you want to borrow and how long for. This will result in your personal APR.

It’s important to realise this before you apply – particularly if you’re shopping around based on the representative APRs you see advertised. The representative APR can be a useful comparison tool, but not necessarily the rate you’ll receive. 

You might not know your personal rate until after you’ve applied for a loan, and simply applying could affect your credit rating. This is because lenders will usually check your financial background with a credit reference agency before deciding whether to make you a loan offer, and the checks will be recorded on your file. Once you take out a loan, the lender has to update your credit file.

What’s the difference between APR and interest rates?

When it comes to mortgages, car loans, and other types of personal loans, the difference between APR and interest rates is important. In these situations, an interest rate is simply a percentage of the loan which is what you're charged for borrowing. An APR includes other fees that may be charged as part of the lending process.

However it’s worth noting if you are comparing credit cards, there's actually no difference at all.

Click here to read more about interest rates and the different types.