You may have seen the Annual Percentage Rate (APR) of various loans mentioned in loan advertisements. Seeing those advertisements, you may have often wondered what APR on a loan is.

Annual Percentage Rate or APR is a percentage of the total cost of your borrowing per year. It takes into account the interest and all other charges collected by your lender. It is expressed as a percentage of the principal amount of your loan or Credit card.

Loan companies are required to mention APRs in advertisements because APR is a key factor in a borrower’s decision-making process. It’s one of the most important factors considered when choosing a loan or a lender.

In order to pick the most beneficial loan for yourself, you must understand what APR means, how it is calculated, and what is a good APR.

What is APR (Annual Percentage Rate)?

Annual Percentage Rate (APR) is a rate that represents the cost of borrowing a loan or another line of credit. It is the percentage of interest, processing fees, and all other additional charges paid on a borrowing over the principal amount. It does not take into account the compounding of interest.

An APR is a measure to compare various lenders or loan products. You can use it as a parameter while selecting a lender for your needs. You can find out what is APR on a credit card, a loan, or any other line of credit using the mathematical formula of APR.

APR Explained: The Formula For Calculating APR

Understanding this formula can be helpful for learning what is APR on a loan. The formula for calculating the annual percentage rate is:

Annual percentage rate APR = ((Fees + Interest)/Principal)/n * 365 * 100

Where:

Interest = Interest paid on loan during the specified period (in £s)

Fees = Processing fees or any other additional charges on loan

n = Duration of the loan (in days)

Example 1: APR of a loan

Let’s calculate the APR for a personal loan of £1000 with an interest rate of 15%. Assume that the lender has charged £10 as a processing fee for the loan. The loan is to be repaid within 180 days.

Based on this data,

Interest on loan= £1000 x 15% x 180/365 = £74 (rounded off)

APR = [(74+10)/1000]/180 x 365 x 100 = 17.03%

The APR for the loan is 17.03%. The borrower can compare this rate with the APR offered by other lenders to select the best option.

You can also find out the APR of a loan using an APR calculator.

Is an APR the Same as an Interest Rate?

The annual percentage rate is not the same as the interest rate on a loan. Both APR and interest rate are expressed as percentages, but APR is a broader term. Unlike interest rate, APR takes into account the entire cost of borrowing the loan, including additional charges. Lenders collect processing fees and other charges to cover their administrative costs.

We can say that an APR gives a better idea of our borrowing cost than an interest rate because it represents the complete cost of borrowing. As a result, APR is used more prevalently to compare various loan options.

Read this blog post to find out how to calculate interest on a loan in the UK.

What is APRC (Annual Percentage Rate of Change)?

APRC is another measure of the total cost of borrowing a loan. It is similar to APR, but it represents the annual cost of a loan over its entire lifetime. Mortgage lenders are required to inform you about the APRC of their products.

APRC is helpful for making decisions about longer term loans because it’s a more realistic measure of the borrowing cost. It considers the total amount of interest paid over a loan’s duration along with legal fees, processing fees, administrative charges, etc. APR assumes the same interest rate, but APRC incorporates the changes in the interest rate and fees as well.

For instance, some lenders offer mortgages with introductory offers. A lower interest rate is charged for the first few years and a higher APR is charged for the rest of the term. One cannot judge the loan based on its initial introductory interest rate. However, APRC considers this future interest rate change and provides a realistic measure of borrowing cost.

APR on Credit Cards

The method of computing what is APR on a credit card slightly differs from that of a loan. Computing the APR on a credit card can be tricky for credit card providers. One does not use their full credit limit every year that they use a credit card. If a person does not exceed his credit limit during the year, they will not be charged any interest on the card and their APR will be 0%. Also, credit card issuer companies offer variable APR that changes with market conditions.

However, credit card companies need to quote an APR on credit cards to help the lenders choose a card. They use a standard format to compute the representative APR on credit cards.

The APR on credit cards is computed based on how much it will cost if you borrow an assumed credit limit of £1,200 in a year in a representative example. While computing the rate, it is assumed that the borrower has used their credit limit fully on the first day and it has been paid back in equal and regular instalments throughout the year. It is assumed that while repaying the credit card balance through the year, you incur no further expenses to your credit card.

Now that we have cleared what is APR, let’s take a look at how to decide whether an APR offered to you is good or bad.

Representative vs Personal APR

During the process of borrowing money, you may notice that the actual APR on your loan was different from the one advertised by the lender. This happens because the APR that you use to compare loan products is a representative APR. The annual percentage rate that you actually get is your personal APR.

Before you calculate what is APR on a loan, you must understand the difference between representative and personal rates.

Representative Annual Percentage Rate

The annual percentage rates that a lender advertises are called the representative annual percentage rates. It is calculated in a regular manner, after considering interest as well as additional charges. However, not all applicants will receive credit at this advertised rate.

The bank has to give credit at this rate to at least 51% of those whose application was accepted. It means that 49% of the applicants, may need to pay a higher APR on their loans. In some cases, some lenders might even give you a lower or discounted APR.

Lenders do not select random applicants who must pay more for their loans. Actual APR varies according to the eligibility of the borrower.

Personal Annual Percentage Rate

The rate that the lender actually offers to the borrower is called a personal annual percentage rate. For at least 51% of the accepted applicants, it will be the same as the representative APR. For others, it will be higher. Lenders decide this rate according to the borrower’s credit score, credit history, and other financial parameters.

Before you judge what is a good APR, you must be aware of the factors that affect the APR of a loan or other line of credit. If you can keep these parameters in check, it is likely that your lender will offer you a favourable annual rate.

Factors That Affect Your Personal Annual Percentage Rate

1. Type of Credit

Lenders charge different interest rates and additional charges for each type of credit. They might charge higher interest rates for riskier products like unsecured loans or bad credit loans. Naturally, the APR is also different for various loan types.

For example, you cannot compare the APR of a payday loan with the APR of a housing loan. The rate of a payday loan is going to be higher than that of a housing loan because a payday loan is riskier.

2. Credit Score

A credit score is a measure of your creditworthiness. Your personal APR can change according to your credit score. It can be higher than your representative APR if you have a poor credit score. Again, this is related to the lender’s risk. If you have a low credit score, you are viewed as a riskier customer, and you will be charged a higher interest rate.

If you don’t know what your credit score is, you can check it on the website of any credit reference agency for free once every year.

Improving your credit score will help you secure a loan at a lower annual percentage rate. Do you have a poor credit score? Check out this guide on how to improve your credit score in 30 days.

3. Loan Amount and Duration

APR also changes according to the amount and duration of the loan. For instance, the interest rate of short-term loans and long-term loans like housing loans will be different. The charges levied on these loans can also differ. This affects the APR on these loans.

Should you prefer short term loans or long term ones? Check out this blog post about short term loans vs long term loans to find out.

4. Income

An important criterion that lenders check while deciding your APR is your income level. A lender will mark you as a high-risk customer if your regular income is low. It means that your personal APR is likely to be higher than your representative APR.

Do you earn a low income but want a loan? Read this blog post to learn about 5 simple ways to boost your income.

What is a Good APR?

Since APR represents the cost of borrowing, the lower the APR the better. However, there is no standard answer to what is a good APR. Whether your APR is good or bad depends on your financial situation. For instance, for a person with a poor credit score, a higher-than-standard annual rate can seem favourable.

Final Thoughts

Annual Percentage Rate (APR) is an important criterion that borrowers use to compare loan products and lenders. It represents what cost you will incur for getting the credit you are applying for. The lower the APR, the more favourable the credit. So, if you are planning to apply for credit, you must understand what is APR, how it works, and the factors that affect it.

Frequently Asked Questions

Disclaimer: The information given above is provided for reference only. This is not financial advice.

Related guides:

What Is A Fair Credit Score

Why Is My Credit Score Different On Different Sites

Why is the APR For Payday Loans So High