What is “APR”?

March 31, 2022

Category:

3 min read

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Origins

You will hear a lot of new terms when applying for or dealing with credit; APR is an important one to get your head around. You may have seen the term APR used in reference to everything from credit cards to mortgages and loans. Understanding how APRs work and how banks calculate them are vital to making better informed credit decisions. 

APR – or ‘annual percentage rate’- is a rate used to help those borrowing money via a credit card or loan understand the total cost of borrowing over the period of a year. Importantly, the rate includes the interest rate and any additional standard fees a borrower will incur. Simply, a high APR means that a borrower will pay a higher interest rate on any money borrowed and not repaid.  All lenders must display the APR so that various products can be compared fairly.

A practical example might help. If someone borrows £1000 on a credit car with a 12% APR (and doesn’t repay any of their debt), they will be charged £120 in interest over the year. The more time a borrower spreads their repayments over, the lower their monthly cost but the higher the overall interest paid.

Overview

It is important to distinguish between representative and personal APR. Representative APR indicates the rate that at least 51% of those accepted for the lending product will receive. This means credit card providers are only required to give their advertised (representative) APR to 51% of customers that apply, with the remaining up to 49% potentially subject to a higher APR. Hence, representative APR can only ever be used as a guide to what will actually be charged. The rate that an individual borrower receives is called their ‘personal APR’: this may be higher than the representative rate, depending on the individual’s credit rating and personal financial circumstances.

Therefore, to get the best APR rate, a customer will need to have a good credit score. Lenders charge higher APR rates to customers considered a higher risk (i.e., those with a high credit score) who are at greater risk of defaulting and being unable to repay the money borrowed. For example, customers with a poor payment history (i.e., those who have struggled in the past to repay their debts in full or on time) or with multiple credit accounts are likely to have a lower credit score. 

So, what does a ‘good’ APR look like? Generally, credit cards will charge around 18-20% APR, making anything below 18% cheap relative to market trends. On the flip side, anything drastically above 20% is considered a high APR rate: customers receiving such rates should aim to repay in full to avoid paying these high rates.

Verdict

Is APR always the most important aspect of a credit card or lending product? The simple answer is that APR can be a good way to compare different credit cards on offer. However, what a customer actually pays in interest depends on how and when they repay their debts. If a customer pays their balance off on time and in full each month, the APR will not be as important as they won’t pay any interest, irrespective of their APR. However, if they forget or are struggling to pay it off and are subject to a high APR, they will soon be faced with high interest charges. 

Therefore, for those intending to use a credit card mainly for shopping and who know they can repay on time and in full, rewards credit cards – which often have a high APR – can be a good choice. The same cannot be said for those who know they may struggle to repay on time and in full – such consumers would have to confront high interest charges.

Report written by Lauren Ainscough

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