Annual Percentage Rate: What is APR and how does it work?

You need to understand Annual Percentage Rate if you’re planning to borrow money. We explain everything you need to know

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What is Annual Percentage Rate? Also known as APR, the chances are you’ve heard the term but don’t understand it, as research regularly shows most people are clueless about this set of initials attached to most loans.

It can make thousands of pounds worth of difference to your finances, however, so it’s crucial to understand it.  

Our guide explains everything you need to know.

What is APR?

The Annual Percentage Rate (APR) is used to show how much interest you will pay on credit cards and loans over the course of one year. It takes into account the interest rate and additional fees. All lenders have to display their APR before you sign an agreement.

You might think the cost of a credit card or loan is obvious. For example, if you borrow £1,000 at an interest rate of 20% and pay it back after one year it would cost you £200, right? If you paid it back after six months you’d pay half of that. However, it isn’t that simple - and this is where APR comes in.

An APR gives you the overall cost of a debt and allows you to compare against other credit and loan options, on a like-for-like basis. 

For example, the typical credit card APR is now 29.8%, according to data analyst Moneyfacts. Knowing this, you can compare this to Barclays’ purchase credit cards that have APR of 22.9% and 23.9% (opens in new tab) to determine these cards have a lower cost of borrowing than the average, and one has a lower APR than the other.

However, APR can still appear confusing. For example, an interest rate could be 22% per annum but the APR is 27.1% because the £25 annual fee adds the equivalent of another 5.1% interest.

It’s why you should use the APR as just one factor when deciding which deal to go for. If you are looking for a credit card and two cards have the same APRs, look at other criteria — does one have a longer interest-free period, do they offer rewards such as cashback, how do their penalty charges compare?

How does APR work? 

You will see ‘representative APR’ or ‘rep APR’ on credit card and loan adverts. This is the rate that at least 51% of those accepted for the credit deal will get - this doesn’t necessarily include you. 

Only 51% of successful applicants must be given this advertised rate. The rest will likely get a different rate - which is often much higher. It means that you can end up surprised by the final rate you are offered.

A personal APR is the rate you are actually given - this could be the same as the representative rate, or it could be higher. The lender decides based on how your credit score and other financial factors match their criteria.

It’s also worth noting that APR only includes essential fees. Some charges, such as payment protection and late payment fees may not be taken into account, reading the terms and conditions carefully and ensuring you fully understand them is essential.

 What is a good APR? 

Generally speaking, with a loan, the more you borrow, the lower the APR.

With credit cards, rates range from 5% to over 30% and usually depends on your credit score.

0% purchase and balance transfer credit cards often have a 0% APR for a promotional period, which lasts for anything between three and 30 months. It’s best to pay off the card before the promotional period ends or you’ll usually be placed on to a standard interest rate.

Can APR help me calculate how much I will pay? 

Figuring out the amount of interest you pay annually is complicated because:

  • Credit cards have flexible repayments - you can pay back more one months than another, as long as you pay at least the minimum amount  
  • Your lender will usually calculate interest on a monthly or daily basis
  • The APR marked on the advert for the credit card is not necessarily the rate you will ultimately receive

For example, in the best case scenario where you want to be a savvy money saver, if you pay your credit card balance in full and on time each month, you won’t pay any interest at all - no matter the APR.

Ultimately, APR is a useful way to compare loans and credit cards. If you search for a loan on a price comparison site, the different options are often ranked by APR. But remember, it is not necessarily the rate you will receive. 

Is APR the same as APRC?

APRC stands for Annual Percentage of Charge. It is the same kind of term used when comparing mortgages and secured loans. It isn’t to be confused with APR.

When it comes to comparing mortgages, however, some experts think APRC is useless. Lenders are required to display an APRC, but with a mortgage it looks at the total cost over a 25-year term. Borrowers generally go for short-term deals and remortgage every few years, making the APRC somewhat meaningless.

For example, X has a two-year fix with an APR of X% for the whole 25 years. However, for the first two years borrowers pay only X%.

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Katie Binns

Katie is staff writer at The Money Edit. She was the former staff writer at The Times and The Sunday Times. Her experience includes writing about personal finance, culture, travel and interviews celebrities.  Her investigative work on financial abuse resulted in a number of mortgage prisoners being set free - and a nomination for the Best Personal Finance Story of the Year in the Headlinemoney awards 2021.