Understanding APR & How It Works
When it comes to credit, understanding APR is really important. If you are interested in taking out a loan, it’s vital that you understand what APR means. Lenders and brokers extend credit, so you can pay back purchases, but they don’t do it for free. So, from what it stands for to how it works, we’ve explained everything you need to know.
What does APR stand for?
APR is the annual percentage rate of a loan. In other words, it’s the yearly cost of an interest rate or what the lender charges you to borrow money on an annual basis. The percentage is averaged over the full duration of a loan and is a representation of your interest rate.
Understanding APR helps you make better choices when it comes to borrowing money, using credit cards and improving your credit score.
How does APR work?
Annual percentage rate works by first having lenders assess how risky it is to loan you money. Then, they quote you an APR based on your risk level. These lenders perceive low-risk borrowers as those with good credit history and low debt utilisation. A person with these financial qualities may be rewarded with a lower APR than someone with a poor credit history or significant debt.
In general, lenders determine your annual percentage rate based on a number of factors, including:
- The type of loan you apply for
- Your current debt
- Your credit history and current score
What is a representative APR?
The representative APR is an advertised rate that all lenders use to help you compare the cost of borrowing in one handy format. When you see a representative APR, it means that over half of people who’ve taken out a loan of a particular size from a lender have been given this rate.
A few things to note about representative APRs:
- They change depending on loan amount
- Just because a lender has a low or high representative annual percentage rate, it doesn’t mean they’ll offer you the best rate
- The rate you’re offered won’t necessarily be the same as the representative APR
What’s an example of APR?
So, let’s imagine you’re borrowing money with an APR of 10%. If the amount was £1,000, you’d pay an extra £100 over the course of one year. If you repaid it in 6 months instead, you’d pay about* half of that (£50). The sooner you repay your debt, the less interest you’ll pay.
How to calculate Annual Percentage Rates?
To calculate annual percentage rates, you can follow these 5 simple steps:
1. Add total interest paid over the duration of the loan to any additional fees.
2. Divide by the amount of the loan.
3. Divide by the total number of days in the loan term.
4. Multiply by 365 to find the annual rate.
5. Multiply by 100 to convert the annual rate into a percentage.
When considering annual percentage rates, making payments on time and repaying balances in full can significantly impact the way rates affect your loan. Setting up a direct debit and creating payment reminders can help you stay on top of payments.