What the hell is APR? A crash course on everything you need to know.

By Charlotte Yau

APR? Alleviating Private Ryan? Err, no. Aguilera’s Private Recordings? Hell, no. Ah, yes, Annual Percentage Rate.

In the most basic sense, an APR is an annual fee to borrow money, whether that’s a loan or a credit card. Obviously you can’t borrow money for free, so this charge is added on top of any credit you take out. It is essentially the interest you pay, but it also takes into account any other service charges.

However not every company charges the same and actually, a lender may charge you more if it thinks there’s a chance you might not pay it back. Armed with this information, you’ll be able to tell how expensive one source of credit is from another, and whether it makes sense for you to move lenders to pay less.

How do I work it out?

Well first of all, you don’t have to do the maths yourself, just use an online calculator, but we’ll try an explain what’s going on behind those calculators.

Imagine you were desperate for a swanky new car. You got out a loan of £10,000 on which the bank offered you a 4% APR. You plan to pay this back over five years.

You might think that because the rate is 4% (£10,000 ÷ 100 x 4 = £400), it will simply be £400 x 5 years, which would equal £2,000 interest.

But it’s not, because you’ll be making repayments each month, so in fact the amount you are borrowing, and the amount which is liable for interest, is going steadily down year-on-year.

You actually end up paying roughly £1,050 in interest, meaning the total cost of the loan is £11,050.

What about credit cards?

Say you take out a credit card with an APR of 20% and a limit of £1,000, then you blow it all on a one-week, all-inclusive holiday to Ibiza.

It will, in essence, cost you £200 in interest over the course of the year.

£1,000 ÷ 100 x 20 = £200

But because you instantly start making repayments, the interest should gradually lower as the sum is slowly paid off (presuming you don’t make any more purchases).

If you repay the minimum amount each month, which is usually the monthly interest and a bit extra, it will literally take you years to pay it off. So, the quicker you pay of your debt, the less you’ll end up paying overall, which is probably a good thing, no?

If you’re thinking about taking out a credit card and you’ve shopped around on price comparison websites and the like, try using the UK Cards Association online calculator to see how much the piece of plastic will cost you.

Does everyone get the same APR?

In a word, no.

If you see a 'representative APR' advertised, at least 51% of successful applicants must get this rate. This means that 49% of successful applicants could be offered a different rate.

You will potentially be given a personalised APR depending on your circumstances. Lenders like to see whether you’ve defaulted on any other credit repayments, or even whether you’ve missed a mobile phone bill.

APRs also vary depending on the amount of money you borrow and how long it’ll take you to pay it back .

I feel total cost of ownership is missing here?

Things to be aware of

The APR does not include the fees added on if you miss a repayment on your loan or credit card. It also doesn’t include cash withdrawal costs for credit cards or the cost of transferring a balance from one card to another.

If you see the word ‘variable’ next to an APR then the rate may change at any time, even after you’ve signed up for it.

The APR for payday loans looks excruciatingly high because despite being short-term loan agreements, the rate has been stretched out as if they were lasting an entire year. This still doesn’t make them affordable nor a recommended source of credit!

Annual Equivalent Rate (AER) is something totally different and relates to the interest earned on savings. 

Top takeaway

Check the APR you pay on any credit cards and calculate how long it will take you to pay it off using the amounts you currently do. See whether you can up your monthly repayments or get a better deal elsewhere (taking balance transfer fees and any post-introductory rates into consideration). 

Do you know your APR from your CCJ? Don't worry, join the club. Heres a handy article that translate all this financial jargon.

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