Borrowing Money: Interest Rate & APR Explained

In simple terms, an interest rate verifies the cost of borrowing the money from a lender, whereas an annual percentage rate (APR) gives you a precise picture of the total borrowing costs. This is because it considers other fees that may be associated with the loan.

In Q3 of 2020, the total amount of money lent through unsecured loans in the UK was £33.9 Billion.

Personal Loans Within The UK by Postcode, UK Finance

When making a decision on the type of loan you want to apply for, you should pay attention to the APR. This is because it will be the actual cost of the overall financing. The interest rate and APR are two of the key things to check when applying for a credit card, too.

What is APR?

APR stands for Annual Percentage Rate and it is the annual rate charged by a financial institution to lend money to its customers. Within an APR, it’ll consider the total interest that will be made against a loan and all the other fees that may come along with it.

Typically, these could be fees to service the loan, early repayment charge, or fees to originate the credit. Once all these fees are finalised and calculated, it’ll produce your annual percentage rate (APR). As this is a yearly figure, it can be broken down monthly by dividing it by twelve, which will give you the actual monthly rate.

What are the different types of APR?

When looking into APR, you may come across two main APR types. These are:

  1. Representative APR: Financial institutions are required by law to show this to provide an example of what your monthly/ annual costs may be. According to Moneysupermarket, only 51% of people will be offered the Representative rate. If you are one of the 49%, you’ll be offered a Personal rate.
  2. Personal APR: This is a rate given when you actually apply for a credit card and is influenced by several factors. This includes your credit score, previous lending, salary, etc.

What is Interest Rate?

An interest rate is percentage uplift applied to loans as a way of payment for providing you with the money. When you apply for a loan from a financial institution, you’ll borrow a certain amount. That amount is called the principal. The principal needs to be paid back, and because the lender is risking their capital by letting you borrow the “principal”, they put a charge on top of it that is called the interest rate.

Now, do not think that you’ll only need to pay both the principal and interest rate back. As this isn’t the case as almost all lenders will pile on various fees for using their services.

Each company and loans they offer will provide you with different fees and packages, etc, and it’s a good idea to search around before choosing your lender. To understand the overall costs with the additional fees, you’ll need to ask for the total APR rate.

What are the different types of interest rate?

Before going ahead with the loan, you should be aware that there are two main interest rate types. These are:

  1. Fixed-Rate: This is when the interest rate will stay the same throughout the whole period of the loan.
  2. Variable Rate: Unlike the above, a variable rate loan’s interest rate could fluctuate during the duration of the loan.

Depending on your personal situation, both loan types can have positives and negatives. A fixed-rate is reliable, but with a variable rate, your payment may become cheaper if the market’s interest rate was to fall. However, if they were to increase, so would your interest rate.

So, always check both the interest rate and APR whenever you borrow money from a financial institution. Otherwise you may find yourself searching for the different ways to get out of debt!

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