What is APR?

 

APR is a standardised way of comparing two like financial products with each other- the higher the APR, the more expensive that product will end up being for you.

*stands on soapbox*

Incidentally, the reason we have a standardised measure is from an EU regulation which states that all credit must be explained clearly to customers with a standardised measure so they are fully informed before making a choice- consumer rights is something the EU has been getting right for a long time. The UK had similar regulations before this directive was passed, but the financial institutions interpreted them in an unrepresentative fashion, so this has made things more fair.

*puts soapbox away*

Disclaimer: the below is not financial advice, and you should not take it as such.

The formula is complex (I have included it at the bottom of this post), but it depends on how much you’re paying compared to the original amount you borrowed, how frequently you’re repaying, and for how long.

Assuming a monthly repayment, the more time you take to repay it, the higher the APR, and the higher the original amount:payment ratio, the lower the APR.

When you go online, you can set the original amount vs length of time, so the APR can be calculated.

For a £5 000 loan over 3 years, the Bank of Scotland gives me 9.9% (paying a total interest of £763.96), while Santander gives me 4.9% (paying total interest of £381.28). Given that the BoS interest is double that of Santander, and the rate is double(-ish), this seems to be a good indicator.

As I mentioned above, APR is representative and will vary from person to person depending on credit rating and other factors. But the lender still needs to quote a figure, so to do that, it looks at the business it secured over the past year, and follows the below guideline from the department of Business, Skills and Innovation:

The Representative APR must reflect at least 51% of business expected to result from the advertisement. The standard information must be representative of agreements to which the Representative APR applies.

 

So if I apply for the Santander loan above, I can be sure that 51% of customers who applied for something similar got what at least they asked for. There will be others who received lower and higher APRs.

Unfortunately, APR isn’t so useful when it comes to short-term loans. Because APR must be measured in the amount of years that has passed since borrowing started, a loan over a few days or weeks will produce really skewed APR.

For example, a popular payday lending site offers loans of £100 that can be repaid in 13 days: the total repayment is £110.40.

So you’re paying £10.40 to borrow £100- whether you think this is reasonable is entirely up to you, but the APR for this is 1 500%. If the interest went up to £15, the APR would increase to over 4 000% for an increase of just £3.60, rendering any reasonable comparison obscured by high numbers.

This is the same APR if you lent me £10 and I paid you back a couple of weeks later and got you a bottle of beer for your trouble. Not that I am making any kind of case for these companies, you understand, rather I’m saying it’s important to look beyond the initial figure in these cases.

Lenders generally now give you a “total to repay” figure, and when considering lending, it’s best to use this as well as APR to inform you of the right choices to make.

The formula is here (shamelessly copied from Wikipedia: those of you of a non-mathematical disposition look away now):

Screen Shot 2016-02-27 at 10.29.25

For a one-off payment like a loan, the left hand side becomes a single figure, but it still requires a computer to solve.

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