When shopping around for the best possible deal on a loan, you will need to understand the difference between the interest rate and the annual percentage rate, the APR, in order to calculate your repayments. So, what is an interest rate? What is an APR? What is the difference between the two, and how will it affect you?
An interest rate is usually calculated yearly, and represents the interest charge the lender is making in exchange for permission for the borrower to make use of the money for a given amount of time. If a lender is charging $17.50 a year for a loan of $100, you divide the total interest by the total value of the loan. $17.50 divided by $100, and then multiplied by 100 to give a percentage, will give you, staggeringly, 17.5%. That’s your interest rate, and people find them pretty easy to understand – a charge based purely on the sum of money you have borrowed.
Annual Percentage Rates (APR)
The APR is different, and is calculated differently. It includes the interest, as well as various other costs, which you should investigate to make sure they are giving you the best possible value. Additional costs could include payment insurance, arrangement fees, exit fees, anything of that nature, depending on the type of loan. Although the APR might sound as though it is trying to catch you out, it is actually the figure on which you should rely, as it reflects the total cost of your credit, instead of just your interest.
The APR is generally higher than the Interest Rate because of the additional items that comprise the charge, but it also makes the assumption that you will be carrying the loan across the full term, without taking into account early repayments, overpayments or anything of that nature.
When shopping around for the ideal loan or mortgage to fit your circumstances, keep a close eye on the APR, as it is much closer to the amount which you will actually end up paying. Having said that, you do also need to keep a grip on the level of your interest rate, as this may be subject to changes in the base rate of interest set by the central banks. If interest rates rise, you need to know your previous interest rate in order to quickly calculate how it will affect your payment schedules.