What are APRs and how they impact the cost of a loan?

If you follow the news, you’ll probably be aware that the Bank of England (BoE) recently increased the base interest rate from 0.5% to 0.75%. This represented only the second base rate hike in the last decade, while it will immediately impact on the cost of borrowing and the repayment of variable mortgage products in the UK.

This brings us neatly on to the Annual Percentage Rate (APR), which is a method used to measure the base interest rate and all other charges that are applied when borrowing money.

The APR that is applied to a loan or credit card will ultimately determine the total cost of borrowing and the rate of interest that you’ll pay annually to lenders. But what else do you need to know and how does it impact on the total cost of borrowing money?

What Else do you Need to Know About APR?

Whenever you apply for a personal loan, a credit card or enter into a hire purchase agreement, the lender will extend an offer with a fixed or variable APR.

In simple terms, this represents a standardised way to show the total cost of borrowing, based on the amount that you request and the number of years over which the repayment can be spread.

It’s calculated using a stringently observed formula, which is laid out in detail in the Consumer Credit Act of 1974 and applied to all lenders.

This formula takes into account several factors, including the interest rate and whether this is applied by lenders on a daily, monthly or annual basis (this will usually depend on the nature and the type of the loan). Any lender fees and compulsory charges are also factored in here, creating a total cost that will indicate precisely how much you need to repay.

Reviewing APR in Relation to your Loan

While this standard formula is applied across all types of financial product, the APR that you’ll be required to pay will vary considerably across different iterations of loan and credit card.

For example, personal and unsecured loans tend to carry higher rates of interest and APR, as this helps lenders to offset their greater risk. Competitive unsecured loans up to £3,000 tend to offer between 35.9% and 99.9% APR, with this having a direct impact on the amount that you’ll be required to repay each month.

In the case of high-risk payday loans, firms now apply an average APR of up to 1,500% to their products. This has fallen considerably in the last few years after the government introduced a 0.8% daily interest cap and dictated that borrowers will only ever pay a maximum 100% of their original loan in fees and charges.

The contrast with long-term secured lending is stark, with products like mortgages applying a significantly lower APR. In fact, the average APR for a 30-year fixed mortgage is estimated at 4.71%, with 15-year alternatives hovering around the 4.16% mark.

Regardless of the type of loan or financial product that you apply for, you’ll need to take note of the associated APR and ensure that you understand the total cost of borrowing. This will help you to make informed decisions and achieve far greater financial security in the future.