Peter Carville is a freelance article writer who writes for Financial Facts about the current financial news and the credit crunch.
If you’ve ever bought a house or a car, or you’ve made any type of purchase with a store or credit card, then chances are, you’ve come across the term APR.
APR is simply an acronym for ‘Annual Percentage Rate’. When you’re shopping for finance, whether it’s for a car loan, mortgage or credit card, the APR is there to guide you during your search for the best loan on the market.
Legally, all banks and lenders must provide consumers with information about the costs and terms of a loan, under the Truth in Lending Act. The intention of the Act is to help consumers fairly compare the different loans offered by various financiers, so they can make a decision without being misled or deceived.
Although it sounds simple, the APR is actually based on quite a complex mathematical formula. Essentially, it is a measure of the cost of credit, expressed as a yearly rate.
The APR reflects the amount of money being financed, the interest rate, the timing of the payments, and any other fees and charges – such as administration costs and broker charges – that are associated with the loan. It would be nearly impossible for consumers to compare all of these costs with multiple lenders on their own, hence the APR.
Because the APR takes into consideration all of the various fees and charges associated with your loan, it is almost always higher than the actual interest rate attached to the loan.
For example, if you have a fixed rate mortgage, the following could apply:
Initial interest rate: 8%
Loan term: 30 years
Loan amount: £90,000
Total prepaid charges: £2,673
APR: 8.3205%
(Example source: www.charterfinancial.net)
When advertising any form of credit, the law requires that lenders ensure that the APR is shown more prominently than any other rate advertised on the page.
If you have a fixed rate loan, the APR cannot change during that fixed period. If you’re loan is attached to a variable rate, however, you have no guarantees that the APR will remain the same during the life of the loan. This means that if your bank raises its interest rates, the APR on your home loan or credit card will also go up – but if the bank cuts its interest rates, your APR will likely go down.
If you’re looking for any type of loan, comparing credit card APRs, for example, of the different products available is often the best place to start, but it’s important to read the small print and consider all aspects of the loan, rather than simply taking the deal with the lowest APR. Every loan has its own set of conditions, penalties and restrictions, so the cheapest rate may not always be the most suitable product for you and your situation.
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