When you borrow any sum of money from a bank or lender, the APR indicates the actual rate of interest you will pay on your loan.
If you’re looking at taking out a loan, credit card or mortgage, it’s more than likely you’ve come across APR. It’s worth considering when comparing different financial products on the market, to help you get the best interest rates available.
Understanding how the APR works can help you make the right choices for your financial situation when borrowing money. Read on to find out more.
What does APR stand for?
APR stands for Annual Percentage Rate, which is the yearly cost of borrowing you will repay when taking out a loan. The APR is usually written as a percentage of your loan amount and includes any interest, charges and agreed fees, on top of the amount you borrow.
All banks and lenders must declare APR up front so you can compare financial products. The amount of APR charged may vary from lender to lender and affects the total amount you have to pay back.
How does APR work on a loan?
When you borrow money, you should expect to pay back the original amount borrowed plus the interest. But there may also be other costs, such as an arrangement fee, set up fee or other charges. This is where the APR can help, as it is designed to indicate the total cost of borrowing, including all these costs.
Bear in mind that, you’ll face lower monthly repayments if you spread the cost over a longer period, but you’ll end up paying more in the long term.
How to calculate APR on a loan
The APR on a loan is usually calculated for you by the lender. The percentage is calculated by:
- Adding together the interest amount and any compulsory fees or charges.
- Dividing this amount by the loan amount borrowed, then dividing again by the number of days in the loan term.
- This value is then multiplied by 365 (for days in a calendar year) to work out the annual rate, and then by 100 to convert it into a percentage.
So, let’s say you want to borrow £5,000 over two years at a 5% interest rate, with a £250 set-up fee. The APR would be 7.5%, including your interest rate and fees. You can then compare this amount to other loans to see which one offers the best rate.
What is representative APR?
Some loans are advertised with representative APR. This means that at least 51% of people who are accepted for the advertised loan should receive that rate or lower. The other 49%, however, may end up paying a different, higher rate than initially advertised.
While you may assume you will get the lowest rate with the lender offering representative APR, this isn’t always the case. At the time of application, there’s a chance you’ll be given a personal APR based on your unique financial situation. This could be the same or lower than the representative APR, but it could also be higher – so it’s worth bearing this in mind when weighing up your options.
What is an exact APR?
With exact APR, you usually know the full sum of APR you’ll pay from the moment you see it advertised. In some cases, this could mean you’ll be paying more than the advertised rates on other loan products. On the other hand, because of how exact APR works, you’ll have a better idea of how repayments look in the long term.
What is a good APR for a loan?
For a good APR, lower is always better. A lower rate means you should be paying less, saving you more than with some of the higher rates on the market.
Remember that the final cost of a loan depends on how much you want to borrow and how long you take to pay it back. The longer the terms of your repayments, the more a loan usually costs overall due to the additional repayments. Knowing your credit score can be useful here, especially if it’s good. If your credit score is healthy, you might have a higher chance of being offered better terms from your first choice of lender.
It is worth scouring the market to find a loan with a lower APR, as it can help make your repayments more manageable. Ideally, you want your money to go towards paying off the loan, rather than being spent on interest.
At Norton Finance, we can guide you towards financial products that meet your needs and help you make that final decision in choosing a loan that works best for you.