APR stands for 'Annual Percentage Rate' and it's used to describe the true cost of money borrowed via mortgages, loans or credit cards etc.
The APR calculation takes into account -
- The interest rate
- When it's charged (daily, weekly, monthly or yearly)
- Initial fees (a bank will often charge a fee when a finance deal is signed)
- Any other costs applicable to the loan
All lenders have to calculate APR the same way which is good news as it enables you to make a direct cost comparison between different lending products.
Why APR is important
Without an APR figure it would be easy for lenders to hide the true costs of their deals. For example:
- A bank offers a mortgage deal with an interest rate of 4.8% plus an arrangement fee of £1,500
- Another bank offers a mortgage deal with a rate of 5.2% and arrangement fee of £150
So which deal is cheaper?
It's actually difficult to work out as the first has a cheaper interest rate but high fees and the second a more expensive rate but a far cheaper fee.
It's therefore possible for the mortgage with the higher interest rate to be cheaper than the one with the lower rate because of the arrangement costs.
See how it can all get confusing without an APR figure? If APRs were used the costs would be combined with the interest rate it would be possible to see instantly which deal was better value.
The fact it includes charges means sometimes the APR can be a bit confusing. It is possible the interest rate is 14% per annum, but the APR is 17%, as the impact of the charges adds the equivalent to another 3% interest. Yet this is useful as it allows a true comparison.