Money fitness tip
Use the APR to compare the overall cost of the loan. But also look closely at the total amount payable, the interest rate and the charges, including those for missed and late payments.
The APR allows you to compare credit products to help you work out which is the cheapest. It is a representation of the cost of a loan and allows you to compare similar loans from different providers.
It will vary from company to company and between products. It works best when comparing similar types and amounts of credit over similar periods.
The APR includes important factors such as:
- the interest rate
- how you must pay back the loan, such as the length of the loan agreement (known as the ‘term’), when you should make the repayments and the amount of each repayment
- fees or charges.
If you borrowed £10,000 over 5 years at 7.5% APR, your monthly repayment would be £200.38 and the amount you'd repay in total would be £12,022...
Generally, the lower the APR, the better the deal, so if you are thinking of borrowing money, shop around.
...but if you borrowed the same £10,000 over 5 years at 15% APR, your monthly repayment would be £237.90 and the amount you'd repay in total would be £14,273.
That's £2,251 more!
Check out the term
Another thing to consider is how long the loan will last. Spreading payments over a longer term will mean you pay less each month. But you will end up repaying more on a loan that runs for longer, because you will be paying interest for longer.
And if you borrowed the £10,000 at 7.5% APR but over 10 years your monthly repayment would be £118.70 but the amount you'd repay in total would be £14,244.
Check the rate you see to the one you're offered
Where an APR is shown in advertising, this must be a 'representative' APR which means more than half of new customers should get this rate or better.
Check whether the rate you're offered differs from the advertised rate and check again before you sign the credit agreement. The rate may be higher if you have a poor credit history.
But don't just look at the APR. It doesn't include all the costs associated with a credit agreement – so make sure you read it thoroughly to find out what else you will have to pay.
Also look at the total amount payable – and check that you can afford the repayments.
Check the EAR if you're comparing overdrafts
If you are borrowing money in an overdraft, you will most often be quoted an Equivalent Annual Rate (EAR). Unlike the APR, this doesn't include any administrative charges for going overdrawn. Instead, it will give you an idea of how much your borrowing will cost if you were to be overdrawn for the whole year.
Such calculations would include the cost of compounding, or interest on interest, the rate of interest and how often it will come into play during the year when you remain overdrawn.