APR and interest rates are common terms that you may have heard thousands of time. You must have come across these terms while applying for a credit card or even when you are taking out a mortgage. If these jargons are confusing you, then read to the end.
What is APR?
APR stands for Annual Percentage Rate. It is the overall cost of borrowing a loan. That means it includes:
- Interest rates
- Closing costs
- Loan origination fees
- Mortgage insurance
- Any other additional charge
Lenders show you APRs when you apply for a personal loan. However, the interest rate that will be charged on the loan is different from the APR.
What is the Difference Between APR and Interest Rate?
Interest Rate: This is the rate of the loan annually. That means the money that you have to pay on the principal amount borrowed. It doesn’t take into account any other charges. Hence, only using an interest rate, it is difficult to calculate the monthly repayment amount.
APR: As it takes every other fee and charges into consideration you will know exactly the amount that you need to repay every month towards your loan.
Let’s take an example for a clear understanding:
If you had a 10% interest rate on a £3000 loan for 24 months, you will pay £138.43 each month and the total repayable amount will be £3322.32.
However, if you borrow the same amount for 24 months at 10% APR, you will have to pay £137.84 each month. That means the total repayable amount will be £3308.13.
Please note that the APR takes into consideration of other charges as well.
How Does APR Work?
APR allows a true picture of the borrowing. We often assume that the lender offering a loan with low-interest rate is the best deal. However, it is a wrong practice to compare lenders. Always compare offers based on APRs to know the actual cost of the loan.
You can calculate APR in these 5 easy steps:
- Add the total interest paid over the loan term to additional fees (if any).
- Divide the result (1) by the amount of loan that you’re planning to borrow.
- Divide the result you get from (2) by the loan term (convert the term into days).
- Multiply the result (3) by 365. You will get the annual rate.
- Again, multiply the result (4) by 100 to convert it into a percentage.
What is a Good APR Rate?
If you are borrowing a personal loan, remember that your APR depends on the loan amount. The more you borrow, the lower will be the APR. Every lending company has its lending criteria based on which they offer you quotes. However, there are a few things that influence the APR that you receive from lenders.
- Your credit score
- Debt utilisation ratio
- Annual income and expenses
- Loan term and amount
- Employment history
What is Representative APR?
A representative APR is offered only to 51% of the successful applicants. That means not everyone who is approved for a personal loan will get the advertised APR. Rest of the successful applicants will have to pay more than the rate that was advertised.
Finding a personal loan that offers low APR is not challenging if you know how to compare loans. Ensure that you compare at least 4-5 different offers before making any decision. Explore and shop around to get an overall idea of the APRs that are available to you.