Whether you are looking at auto loans, mortgages or credit cards, one thing stands out and that’s the APR. To most people, the APR is just one of the numbers out there whose implications on credit arrangements seems vague and sensical only to the elite. On the contrary, knowing what APR is and how it affects your credit facilities is super important.
In this article, we shall look at what APR stands for, the different types of APR and why they matter in your financial life. Let us dig in!
What is APR
APR stands for the annual percentage rate. It is the cost of borrowing money stated on an annual basis. It comprises the interest you’ll pay on the loan and standard fees including broker fees, transaction fees, legal fees, origination fees, legal fees, application and processing fees, underwriter fees and some closing costs.
Assuming you are taking unsecured loans worth £10,000 to be repaid within 3 years. If the lender gives you an APR of 5.5%, you’ll repay in monthly instalments of about £301. At the end of the loan period, you’ll have paid a total of £10,848.60.
Therefore, the interest and fees represented by the 5.5% APR amount to £848.60. Your monthly repayments remain the same but the proportion of principal and interest you pay differs. At the beginning of the loan term, you’ll pay more interest and less principal. However, as the loan repayment progresses, the amount of loan principal repaid will increase and the interest on the loan will reduce.
There are different types of APRs out there and understanding them will help you determine the true cost of your credit card debt or other loan facilities. Here is a look at some of them.
Also known as promotional APR, this is an annual percentage rate that card issuers give their customers for a limited time. It is often lower than the actual APR and after the period of offer expires, the rate goes back to where it was meant to be. Introductory APR is oftentimes used for transactions such as cash advances, balance transfers, and others.
Whenever you see a loan advertised with a certain representative APR, it means that at least 51% of the customers will get that rate or a lower rate than what is advertised. In summary, the representative APR gives you an indication of the rate most customers will get. For instance, you may come across a Barclaycard Platinum card with a representative APR of 21.9%. This means most customers will get approved at a rate same as 21.9% or below.
When you apply for a loan, the rate you get depends on your circumstances including your credit history, how much you are borrowing and so forth. Therefore, the personal APR is the actual rate you are approved for when you apply for a loan or card.
Many loans or credit cards out there come with a Representative APR (Variable). This means that the rate may change in the course of the life of the loan in light of emerging issues. For instance, if the Bank of England Base Rate changes or you miss a monthly payment, the rate will also change.
This is the rate you get charged when you use your card to make a purchase in-store or online. However, if you faithfully pay off your credit card balance every month, you won’t have to pay any interest on purchases made through the card.
How APR works
Generally, APR is charged on your loan balance. It could be a personal loan or credit card debt. While on most loan products you must pay APR, you may avoid paying APR on credit cards if you use them wisely. For instance, if you always pay the minimum balance or pay more than the minimum balance, you won’t be charged any interest because the balance will be zero.
The APR is determined in part by the Bank of England base rate. This is the rate set by the Monetary Policy Committee (MPC) and helps in determining what banks charge their customers in interest.
The bank connected to your loan or credit card will structure the APR to calculate and compound interest either daily or monthly. This compounding will determine how much you’ll pay in interest on your loan.
Why APR matters
APR represents the cost of borrowing. The higher the APR, the more expensive the loan and vice versa. When comparing the APRs of different loan options, keep away from loans with higher APRs because they may overwhelm you down the road or completely distort your budget.
When considering various personal loans, APR can be that metric that helps you decide which lender to go with. You must know how much you will pay every month once you take up a loan. To help you with this, there are various online calculators out there that can compute the payable instalments by allowing you to input various APRs.
What affects the APR?
When you apply for a loan, the lender has all the powers to decide the rate at which your loan should be approved. In arriving at your personal APR, certain factors serve as inputs into the lender’s decisions model. Here are some of them.
- Type of credit product: On average, personal loans have the highest APR averaging 9.3%, auto loans come in second at 4.9% and mortgages come in at about 2.8%. The type of credit product, therefore, determines the APR you’ll get.
- Credit score: If you have a higher credit score, you’ll get a much lower APR meaning more competitive rates.
- Payment history: If you make payments promptly, lenders will consider you a good credit risk and will give you good rates.
- Loan term: Long loan terms mean higher risks hence high rates of interest.
The APR is a very important number when comparing loans or credit products. It determines how much your monthly repayments will be and whether you are getting a deal or not. Comparing APRs or having a general understanding of how APRs work will lead you to make optimal decisions in credit applications.