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Know your Borrowing Power: What’s an APR?

Looking from above at someone holding a cup of milky coffee and a mobile phone, with the screen showing what APRs they could get.

When it comes to borrowing money, it can be difficult to know you’re getting the best deal available to you. That’s why we created Borrowing Power. It gives you a 1-10 Zopa rating that gives you a clear picture of your financial health, along with tailored recommendations of how to improve if it needs a little TLC.  It also shows you exactly which Zopa loans you’re eligible for and what APRs or Annual Percentage Rates, you can unlock when you boost your score. (Representative APR 9.9%).  

APRs can be a confusing topic, but they’re really important to help understand the true cost of borrowing when comparing loans from different providers. To help provide clarity in the confusion, we asked Laura Whateley, award-winning financial journalist and author of Money: A Users’ Guide, to explain exactly what an APR is and why it’s good to know how it effects your cost of borrowing. 

If you need a loan or a credit card, how do you judge which one is best for you? While there are a number of factors you might want to take into account, knowing what they’ll cost you in total is top of the list. This is where really understanding what an APR  is comes in handy… 

Start with the interest rate… 

One of the first things you are likely to look at is how much it is going to cost you, usually calculated using an interest rate. That is how much you are going to have to pay each month or each year to borrow money.  

Banks aren’t going to give you a loan for free, and interest rates could be high, so examining them and reducing them as much as possible is key.   

If your interest rate is 20 per cent on a loan of £1,000 you’ll have to repay the loan plus £200 in interest. Though brief warning, it’s usually not that simple, because interest compounds. So if for example you had £1000 on a credit card and you don’t pay it off in full, you end up paying interest on the interest.  

… add the fees… 

You might also have to pay fees to borrow as well or instead of interest. For example, an overdraft might charge a £5 a day fee, or you may have to pay an arrangement fee on a mortgage. 

And you get to the APR 

In order for you to try and compare the cost of different credit cards or different personal loans, one official rate is used for borrowing known as the Annual Percentage Rate or APR. 

The APR is what most lenders will use to advertise their loans and credit cards. It is calculated by taking into account any interest rates or fees, giving you the overall picture of the cost of your debt.  

This means an interest rate might be 15 per cent, but if you are charged fees too, the overall APR could be higher, for example, 20 per cent.  

Beware too that some lenders might charge interest at a monthly rate, whereas the annual percentage rate figure is how much a debt will cost you over the year. 

Make sure it’s not ‘representative’ 

To confuse things further the APRs you see in marketing or on comparison sites are not necessarily the interest rates you will actually receive. Look carefully at posters from lenders and you might notice a key word  “representative”. 

Representative APR is just that, it is an idea of what it might cost you to take out that particular loan, but not necessarily the rate you will end up paying. In fact, many loans will be much more expensive than you may have anticipated. 

Only 51 per cent of those who apply for a loan have to be offered the representative APR. The remaining 49 per cent of customers will usually pay a higher rate. 

Getting the lowest APR you can 

That is why it is so important to sort your credit file out before you apply for a loan. While most people know that a poor credit score will result in being rejected for a loan or credit card, many don’t understand until it’s too late, that it could end up costing you more money, when you go to borrow. 

Something as simple as failing to be on the electoral register, which ends up damaging your credit score, might not prevent you being offered a loan, but the loan may be on the condition you pay a much more expensive price. 

You want to give yourself the best shot possible at getting the lowest APR that you can. The easiest way to do that is to brush up your credit file, pronto. 

Laura Whateley is a freelance writer and author of Sunday Times bestselling book Money: a user’s guide. She has written for a wide variety of publications including The Times, The Guardian, Grazia, Refinery 29, Elle and Stylist Magazine. All views are her own.