When looking for a loan or credit card, you’re sure to come across the term Annual Percentage Rate. This is usually shown as APR and sits next to an interest rate.
APR refers to the total cost of your borrowing on a card or loan for a year, shown as a percentage amount. This is the interest you would be charged for that borrowing and any fees you also need to pay.
APR is a good way to compare the different rates offered when you are searching for a card or a loan but it’s important to understand exactly what APR means.
How does APR work?
Let’s break it down with a real example…
Imagine you want to borrow £1,000 to make some home improvements. You decide to spread this borrowing over 2 years:
£1,000 over 2 years, APR 39.9% (variable)
This would mean:
Monthly repayments of £61.13
A total loan repayment amount of £1,467.21
The APR of 19.9% is an annual amount of total interest and this is then spread over the total loan repayment term which in this case is 2 years.
This means a total borrowing cost of £1,467.21 which is the loan amount plus the interest. Spread over the 2 years of the loan (sometimes shown in months) this would mean monthly payments of £61.13.
This is a simple illustration of a typical loan but doesn’t include any fees or other charges you may find are included with an actual loan when you apply.
What is a good APR?
The is no APR that is good or bad across credit products, but generally the lower the APR offered, the better. A lower APR will result in you paying less interest and lead to cheaper borrowing compared to a higher APR.
APR is an important feature of a credit card. An APR depends on several factors, including your credit score, the type of credit card and its usage. If you have a good credit score, you will most likely get a lower rate for a credit card. But if you have bad credit or want to build your credit, the rates offered to you will most likely be on the higher end.
The difference between APR and interest rate
It can be difficult knowing the differences between an APR and a normal interest rate. Here’s a simple explanation of the key differences between the two:
The interest rate is the cost of borrowing on a credit card or loan. It is shown as a percentage which shows how much you would be charged on the amount you are borrowing.
For example, if you borrow £100 and the interest is 10% for a year, the loan will cost you £110 in total.
The APR shown on a credit card or loan includes the amount of interest to be charged annually. However it will usually also include any fees that come with the credit.
An APR is a representation of how much credit costs and is a useful way of comparing credit cards or loans.
The different types of APR
Most APRs you will see for loans and credit cards will be variable rate (see below for what this means) but it’s a good idea to be aware of the different types you might see when comparing products:
- Variable APR
As mentioned, this is the most common type of APR used with credit cards and loans. This rate is tied to the Bank of England base rate and so can change over time.
- Fixed-rate APR
A fixed-rate APR doesn’t change over the life of a credit agreement. This means it is easier to budget as you will know exactly how much you will need to pay in interest.
- Introductory APR
Sometimes credit cards can come with an introductory rate, which may be slightly lower than their normal rate. Credit card companies use this to promote their products and will last for a certain period of time then revert to the specified rate in the agreement.
- Cash Advance APR
Usually borrowing cash on a credit card can carry additional fees or a higher rate of interest. Some cards may offer a lower rate for cash advances which lasts for a limited time, similar to an introductory rate.
A word on representative APR
When searching for credit cards or loans you may often see ‘representative’ used next to the APR. This is because lenders will offer you a specific rate for their products when you apply, based on your circumstances. But they also want to show an example rate of interest which represents their products. To use a specific percentage rate as the representative APR, a lender must offer this rate to at least 51% of successful applicants.
This means you can easily compare one credit card to another, for example. It also includes any fees or additional charges which may be added on. It’s a good idea to spend some time comparing these rates as although one product may have a lower rate than another, when fees are added you could end up paying more in interest over the long term.