A jargon-free guide to annual percentage rate

Applying for credit is a big commitment.  You need to know whether the credit card or loan you are applying for is the right fit for you.  You especially need to know whether you can afford the repayments and how much those repayments will be.

Unfortunately, understanding this isn't always easy.  There is interest to consider along with fees and all advertisements for credit and the websites of lenders will talk about APR. 

APR can be confusing but understanding it will enable you to make an informed judgement on whether a particular loan or credit card is good value or not. 

What is APR?

APR stands for annual percentage rate.  It is a fee which the lender would charge if you were to borrow the amount you loan for one full year. 

The APR is made up of interest as well as some fees  These could include arrangement fees or an annual fee charged on loans which last for more than a year.  Most of the fees which the lender charges will be included in the APR figure. 

However, the fees included in the annual percentage rate do not include charges such as late payment fees should you miss one or more of your repayments.

Whichever type of credit you are thinking of applying for, whether a short term loan, a mortgage or a credit card, the lender must tell you what their APR is.  This allows you to compare products from different providers and decide which will be the best for you.

Why do credit providers charge APR?

It is probably easiest to think of APR as the lenders profit margin.  If you only paid back the same amount you borrowed the credit provider wouldn't be able to pay their expenses or their staff.

If you borrow £500 and pay back £600 (including the annual percentage rate) the extra £100 you paid in APR is the lenders profit.

How is APR calculated?

This is where things get a little complicated but some examples should help clarify a few things.

The important thing to remember is that APR is different to interest rate.  A credit provider may advertise a loan in which the interest rate is 10%.  However, they must also include the APR figure in their advertising.  This will always be higher because it includes fees as well as interest.

Let's assume you borrow £100 over one year and the interest charged  is 10% per annum:

Loan amount £100

Interest £10 (£100 x 10% interest)

Full amount you will need to repay £110 (the amount you borrowed (£100) plus the interest (£10))

That is fairly straightforward.  However, we now need to take APR into account.

The credit provider may charge a fee for setting up the loan and another fee for admin at the end of the loan.  These fees are added onto the 10% interest to come up with the final APR figure. 

In our example, let's assume those added fees are £5 which is equivalent to 5% of the loan.  Our example now looks like this:

Loan amount £100 APR £15 (£100 x 10% interest + 5% fees = 15% APR)

Full amount you will need to repay £115 (the amount you borrowed (£100) plus the APR (£15))

You can see how APR can make a big difference.  In our example the true cost of the loan (APR) is 50% higher than the advertised interest rate.  On bigger loans this can make a substantial difference.

Why APR matters to you

When looking at a loan or credit card the numbers involved can be bewildering.  There are interest charges and other fees which can easily confuse the borrower.  Which is why APR was introduced.

Every credit provider must, by law, tell you exactly what the APR is on any credit product you are considering.  This makes it easier for you, the consumer, to compare products from different lenders.

If two lenders are offering £100 loans and Lender A's APR is 15% and Lender B's APR is 20% you know that Lender A is charging less and, all things being equal,  a loan from Lender A would be cheaper than from Lender B.

By being able to compare the APR across similar products you will be able to find a loan or credit card which you can afford and you will know how much you are borrowing in total without being surprised by extra fees further down the line.


You just knew there would be a 'but' didn't you?

There are a few other things you need to factor into your calculations.  If you are considering a credit card you may see the interest rate noted as 'variable'. 

This means the APR you are charged could change depending on whether the national rate of interest goes up or down.  If the APR does change the credit provider must give you 30 days notice in writing.

The other factor you need to take into account is that there are two types of APR:

  • Personal APR
  • Representative APR

Both types of APR are calculated exactly how we have described above.  It is the interest plus the fees and the credit provider will display the figure on their website and advertising.  But this figure is usually the Representative APR. 

In other words it isn't guaranteed you will pay the APR stated in the advertisement. 

This means the APR figure you see on the website or advertisement is not necessarily the figure you will be charged.  Representative means that 51% of customers accepted for that loan or credit card will pay the advertised APR but the other 49% may be offered a different, usually higher, APR.

Therefore, your 'Personal APR' the figure you actually end up paying, may be higher than the 'Representative APR' quoted in the advertisement.

Once you know the APR figure you then need to..... 

Work out the true cost of credit

We've seen how APR can differ from the advertised rate to the actual rate you will pay.  So when you are comparing products from different credit providers how do you decide which is best for you?  Let's look at short term loans as an example.

Comparing loan providers

Although Representative APR does mean the actual APR you pay may be a little different to the headline figure splashed across the website it is still the best way to compare loans from different lenders.  But, it should be just part of your calculations.

Earlier in the article we explained APR includes interest and other fees charged by the lender.  But, we also mentioned that the APR will not include extra charges such as late payment fees.  It is these extra fees you need to consider in addition to the Representative APR.

Closely examine the small print on the credit providers website.  Do they charge fees if you miss a payment, are there extra 'admin' charges, do they add fees if you settle your account early, do they charge for sending correspondence through the post, are there any annual service charges?  

It is only when you understand these extra fees that you can work out the true cost of the loan you are applying for.  It may well be the case that a credit provider which charges a higher APR may actually be better value than another lender with lower APR but who adds on a whole series of extra charges.

Satsuma - making APR easy to understand

Here at Satsuma we like to be totally upfront with our customers and that includes APR.  You can use the calculator on our website to see exactly how much you will repay when you borrow from us. 

Unlike other lenders the APR you see is what you will pay.  We can say this because we never charge any extra fees.  Ever.  Even if you miss a payment we will not add any extra fees onto your account.  You can read more about our fees, or the lack of them, here.

In addition, when you become a customer you get access to the MySatsuma portal.  A page where you can find all the information about your account including payment history, scheduled payments and other useful information to help  you keep track of your loan.