What Is the APR (Annual Interest Rate) and How Is It Calculated?

If you are taking out a loan, you will have come across the term ‘APR’. APR stands for ‘annual percentage rate’ and must be included in any credit agreements and documentation.

APR is not simply the annual interest rate that you will pay on your loan. The calculation is actually more complicated than this as it takes other factors into account. Our guide explains what the APR (annual interest rate) is and how it is calculated.

What Is the APR?

This official definition of the APR comes from the Financial Services Authority (FSA):

“APR stands for the Annual Percentage Rate of charge. You can use it to compare different credit and loan offers. The APR takes into account not just the interest on the loan but also other charges you have to pay, for example, any arrangement fee. All lenders have to tell you what their APR is before you sign an agreement. It will vary from lender to lender.”

By taking into account associated fees and charges it is intended to give you an idea of the total cost of the borrowing, not just the interest rate.

How Is the APR Calculated?

The Office of Fair Trading (OFT) says: “The APR is based on the total charge for credit (TCC) which includes interest and other charges which affect the cost of borrowing - even if they are not payable under the credit agreement itself. The APR is an annualised rate reflecting the timing of such charges, as well as the rates and amounts.”

This means that the APR includes not just the annual interest rate but also other charges which may (or may not) fall due over the term of your borrowing.

For example, the interest rate on your loan may be fixed at 10 per cent per annum, but the APR of the loan may be 12 per cent. This is because the arrangement fees and other charges add the equivalent of another 2 per cent interest.

Why Does an APR Exist?

The idea of APR is to make it easier for consumers to compare the true cost of loans and other borrowing. If lenders showed their interest rate only, this could be misleading as some may have much higher fees and charges than others.

So, an APR is designed to take all costs into account to make it easier for consumers to compare the true cost of borrowing.

The APR must be included in all financial advertisements and credit agreements. Again, this is to help you compare the cost of different credit deals.

Disadvantages of the APR

The main disadvantage of the APR is that it doesn’t take into account changing rates. For example, the APR on a homeowner loan is calculated by taking the total interest cover and charges over the term of your loan. If you are on a variable interest rate which changes during the loan term then the APR won’t be accurate, as your interest rate will fluctuate.

Another downside of an APR is that it also takes into account all potential fees and charges, even if you never end up paying these on your account.

If you are comparing any sort of credit including homeowner loans, make sure you take the APR into account. Whilst not a perfect system, it will allow you to compare the true cost of borrowing between lots of lenders.

To use your home to raise money at a competitive APR, please fill this homeowner loan form.