The Financial Group
We simplify all those essential financial decisions
THE EDUCATION SECTION Every month we look at a particular financial topic in a little more detail. This month it is APR (Annual Percentage Rate) ____________________________ What is it? In simple terms, the APR (Annual Percentage Rate) is a measure of how much a given loan or mortgage will cost you in interest & charges per calendar year (based on the full term of the loan). The figure for the APR takes into account all of the normal costs associated with the loan, such as- arrangement fees interest charges any annual charges (which may be the case with credit cards) any other such costs - so as to provide a clear, overall figure for the total cost of the loan. This makes it possible to compare one APR with another. The cheaper the APR, the cheaper loan. But comparing APRs with other types of rates is not entirely straightforward. When not to use APR. Comparing an APR on a mortgage is a fairly pointless comparison, as this will compare the rate over the full term of the mortgage, when most people only hold their mortgage throughout the special deal period, before remortgaging or negotiating another new deal. In this instance a much more accurate method of comparison is a 'true cost comparison' over the period of the deal. This takes into account the monthly payments expected within the deal period and any set up costs incurred to purchase the deal, such as arrangement and valuation fees, etc. As a Company, this is our preferred, and we believe a more accurate, route for comparing mortgages for our clients. Comparing rates. Let's look at an example of why an APR rate is usually much cheaper than an apparently similar fixed or flat rate. Suppose you are looking for a 6 year loan of £1,000. One loan quotes you a flat rate of 5%, and the other an APR of 6%. Car dealers often do this, and quote a 'flat' rate. Which is cheaper? In fact, you can't compare these numbers. They may look very similar at first, but are actually very different. Depending on the exact calculation, an APR of 6% will usually be much cheaper than a flat rate of 5%. This is because: the flat rate is applied to the whole of the loan every year the APR is calculated on the amount outstanding, which is reducing each year. As you are paying the loan back on a regular basis, the interest payment you make reduces. Click here to see an example of the figures Calculating APR The maths for calculating APR is not entirely straight forward (even though it sounds as though it ought to be), especially when a loan has been adjusted to provide fixed monthly payments. As you can see from the illustrative tables, the interest rate appears to change each month, so there's no way you can work out the APR in your head. What you can do with the above example, though, is work out the equivalent flat rate . You pay £210 in interest on a capital of £1,000 - i.e. 21% over 6 years The equivalent yearly interest rate is 21%/6 = 3.5% That is, each year you pay back an additional 3.5% of the amount you borrowed in interest By the end of loan you have paid 21% You can see that our APR of 6% has an annual equivalent of 3.5% flat rate, and therefore is indeed much cheaper than a flat rate of 5% quoted for our 'fixed' example on the pop out screen. Finally, as always, do not hesitate to contact us if you would like further details or information.