## APR explained

**APR**stands for '

**Annual Percentage Rate**' and is a figure that that helps you work out how much a loan is going to cost you in real terms and also helps you compare one loan deal to another.

- The APR is not just the cost of the interest that you have to pay but also includes any other charges used to set up and run your loan.
- The APR shows the cost of borrowing the money over a set period of time which is one year hence annual.
- When you borrow money, every lender is required by law to quote this rate.
- The APR is the best way of comparing one loan to another.
- It was introduced as part of the Consumer Credit Act of 1974 and is mostly used for credit cards, Personal Loans and mortgages.

**What is the difference between the interest rate and APR?**

The interest rate is the amount of money you agree to pay back in addition to the capital (money borrowed) but does not show any additional charges which are involved in taking out your loan. The interest rate on its own is not very useful.

**APR is the magic number in Loans - without it you can not compare loans or work out how much you must payback.****Interest costs + any additional costs = APR**

**As an example look at these two loan offers:**

**Lender One**offers you a loan with an interest rate of just 2%.

**Lender Two**wants double that rate and offers you a interest rate of 4%.

Which deal would you sign up for?

The answer is neither, until you know what the magic number is ie. the APR, only this figure allows you to accurately compare the two deals.

**Lender One**is charging you just

**2%**

**interest**on a loan but also has very

**high administration charges which amount to 3%**of the loan, therefore the total cost would be

**5% ie. APR 5%**

**Lender Two**has a higher interest rate of double lender one at

**4%**, but charges much less in

**administration charges of just 0.5%**, therefore the total cost is

**4.5% ie. APR 4.5%**

So in fact lender two has the best deal even though the headline interest rate is double that of lender one.

*SimplifyLoans Tip:***Never, rely on headline interest rates or introductory special interest rate offers alone in deciding to take out a loan. You always need to know the APR to really understand how much a loan is going to cost you and be able to compare the deal with others on the table.**

**To understand how borrowing works there are three important factors:**

- The amount you want to borrow - this is called the capital
- The interest rate and other charges associated with your loan (APR) you are going to be charged
- The time you want to have to pay the money back - this is called the 'term'

**For example:**say you borrow

**£100 (the capital)**and the

**APR rate is set at 10%**and you want to pay the money back at the end of

**one year (the term)**

Because the APR tells us that in one year the charge for borrowing the money (interest and loan charges) is set at 10% we know that this will cost £10 on a £100 loan. Therefore the total to be repaid will be £110 and the total cost of borrowing loan has been £10.

Now take the same example and imagine you only need to borrow the money for six months. We know that if we borrow for 12 months it will cost £10 so just 6 months will be half that cost at £5. The total to be repaid will be £105 (capital and APR charge) and the total cost of borrowing will have been £5

However most loans require you to make monthly loan repayments back to the lender so every month the capital you had originally borrowed is being paid back and therefore the sum of money you are still paying interest charges on gets smaller.

For example, if you borrow £120 over one year with an APR of 10% and make payments back every month:

- Each month you will repay £10 capital + 55 pence interest ( & loan) charges.
- Therefore after one month you are only paying 10% APR on a loan of £110, then £100 and so on.
- In this instance the total interest charge over the year works out at £6.60 so the total loan amount repaid is £126.60

To calculate the exact cost of a loan and see exactly how your interest and capital get paid off use our

**simple loan calculator**.

Interest rate is the contractual rate that you agree to pay for your mortgage loan. This rate is used to calculate the interest portion of your monthly mortgage payment. Annual percentage rate (APR) includes your interest rate and factors in the prepaid finance charges to give you an average yearly rate. APR can be a good tool to use when you’re comparison shopping for rates.

- Remember the APR is not just the interest charges you will be paying but also represents other costs involved in setting up your loan such as credit checking, administration charges etc.
- The APR is a really useful way to compare two different loans because all the costs are usually contained in it.
- Note that in mortgages you will often be shown two rates, one will be the interest rate on the loan and other the APR rate for comparison with other deals. This shows that although the headline interest rate may look nice and low say 2% this is telling only part of the story, by the time all the administration charges and initial low deals have expired the true cost to you is shown in the APR which may well be 5% plus. The lesson is always look at the APR and not just at the headline interest rate.