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What is an annual percentage rate (APR)?

The annual percentage rate (APR) is the cost of borrowing money over a year. You’ll see an APR quoted for all kinds of borrowing, including credit cards, mortgages and personal loans.

Knowing about APR helps you understand what you can afford to borrow. All lenders must show the APR on the products they offer, so you can easily compare what’s available to suit your circumstances.

a customer smiling and looking at her phone whilst holding a credit card

What does APR mean?

Whenever you apply for a credit card, personal loan or mortgage, the lender will quote a figure known as the APR. It’s short for annual percentage rate. But what is it and what should you know about it?

A simple APR definition would be “the cost of borrowing money over a year.” It includes the amount of interest you’ll pay annually on your borrowing but there’s more to it, as we’ll cover later.

In this guide we’ll look at:

  • How APR works
  • Different APR types and terms – such as ‘fixed’ and ‘variable’, ‘typical’ and ‘representative’
  • Lenders’ APR responsibilities
  • What can affect APR levels
  • What influences APR and what APR you might be offered
  • How to increase your chances of borrowing with a low APR, so it costs you less
  • Answers to other common questions about APR

Why is it important to understand how APR works?

Understanding APR, and the different types to look out for, is an important consideration when shopping around for deals. The rate should give you an idea of how much you’ll have to pay back to a lender on top of the original amount of money you borrow.

This can help you to:

  • Decide whether borrowing is right for you
  • Make better decisions when applying for credit
  • Borrow in a way that best suits you and your spending habits
  • Compare the offerings of different lenders
  • Manage your borrowing and repayments to minimise what you pay on top

How does APR work?

APR includes both the standard fees and interest you’ll have to pay on your borrowing over the course of the year. It’s usually added to the amount you owe on a monthly basis.

If you pay off your balance at the end of each month, you won’t be charged any interest. But any portion of the balance you carry over will then be charged at the APR stated by your lender.

If you spread your repayments out over a longer period the monthly cost will be lower, but the total costs will be higher.

Sometimes the interest rate isn’t the only cost of a credit card. To account for this, APR considers both a card’s interest rate and any other standard fees. This means that the APR percentage offers a more complete picture of how much borrowing will cost.

Also, remember that APR only includes mandatory charges. Some fees, such as payment protection, late payments or going over the credit limit may not be included. It’s important to always read the terms and conditions carefully before applying for any kind of credit.

What types of APR are available?

The most common types of APR you will see mentioned by lenders are fixed, variable, typical and representative. Here’s a handy quick reference to the differences between them:

  • Fixed APR – this rate doesn’t change over a specific period, or even the lifetime of your borrowing, depending on the deal offered. If you’ve borrowed a fixed amount, such as a personal loan or mortgage, this can make monthly repayments more predictable
  • Variable APR – this is tied to an index interest rate, such as the prime rate. If the prime rate increases, so does your variable APR. This means the loan may have a lower APR at first, but your rate could increase over time, making it harder to plan your budget
  • Typical APR – this is a guide to the amount of interest most people are likely to be charged. However, the rate you are charged could be higher depending on your personal financial circumstances and your credit rating
  • Representative APR – this is the advertised rate that at least 51% of those accepted for that product will get. So, almost half of those approved for the deal may not be eligible for this advertised rate, and will have to pay more

Other kinds of APR to look out for:

  • Purchase APR – a credit card’s purchase APR is the rate that’s applied to purchases made with that card
  • Cash advance APR – this is the cost of borrowing cash on your credit card and tends to be higher than the purchase APR. Other transactions might be deemed cash advances, such as buying lottery tickets or exchanging pounds for foreign currency. These types of purchases usually don’t have a grace period and will start accumulating interest immediately
  • Penalty APR – this may be applied if you breach the terms of your loan’s contract, such as missing a payment or making a late repayment. The APR on your loan may then increase for some time. Be sure to check your loan’s terms and any notices your lender sends you about your account
  • Introductory or promotional APR – a new credit card or loan may come with a lower, limited-time rate. It may apply to purchases or specific transactions like a balance transfer

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What are the lenders’ APR responsibilities?

The representative APR must be advertised on all loan products, such as credit cards, mortgages and personal loans when applicable. This representative APR rate must be available to at least 51% of customers so you are able to compare them fairly.

Under industry regulations, all lenders calculate APR the same way. This makes it easier to compare products, so you can choose the one that best suits your needs.

What can affect APR?

APR can be based on the type of transaction you’re making. It can also be different depending on the type of credit you’re applying for. The APR on credit cards is usually higher than that of a car or home loan. How you use your credit card can also affect your rate.

What might influence the APR I’m offered?

The factors that can affect the APR you’re offered by a lender include your credit history, credit score and credit activity. It’s essential to read and understand all the terms and conditions that come with any deal you’re applying for. It’s also a good idea to see what benefits are included, what you have to do to keep them and how to avoid unexpected costs from the APR increasing.

It’s also important to remember that, if you’re offered an introductory APR, this rate will rise once the introductory period ends. Not all issuers use a penalty APR with late payments, and some exceptions apply. So, it’s best to check with your lending provider.

How can I improve my chances of getting a low APR?

It’s at the lender’s discretion whether you’re offered a low APR, but here are some simple steps you can take to improve your chances:

  • Keep a healthy credit score – credit scores are built on your previous experiences of using credit. Good credit practice can improve your credit score and show a lender you are a reliable borrower. Not doing so could harm your score
  • Don’t exceed your credit limit – scoring models look at how close you come to your credit limit. It’s sensible to try and stay within 30% of your available credit to maintain a good score
  • Use your credit cards sensibly – try not to go over your spending limit and pay your bills on time. It’s a good idea to set a reminder on your phone, or consider setting up automatic payments so you don’t forget
  • Only apply for the credit you really need – try not to apply for lots of loans over a short period of time. Lenders may see you as a financial risk, even if this is not the case
  • Pay your bills on time – clearing your bills each month will prove to lenders that you are a responsible borrower. This will help to build a good credit score and improve your chances of getting a low APR offer
  • Keep an eye on your credit – you’re eligible for one free credit report from each of the major credit reporting agencies every year. CreditWise from Capital One is a free tool that can help you track your credit. If you spot any errors, contact the agency or company that provided the report to try and fix the problem and protect your credit score

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Common questions about APR

  • Lenders use an APR calculation formula to work out the rate of interest you’ll pay on the outstanding balance of your credit card, personal loan or mortgage. Depending on the deal you’ve been offered, APR may be calculated daily or monthly.

    Some accounts may have multiple APRs. Card issuers and lenders are required to disclose how they calculate their APRs. It pays to always check the terms and conditions of a credit card or personal loan before you apply for it.

    Also remember that the costs that go into an APR calculation can vary, based on the type of loan you’re seeking. For example, an APR for a mortgage could include the interest rate, fees and more. For a car loan, the APR is determined based on several factors. These can include credit history, loan amount, down payment and the age of the car being purchased.

  • A good APR for a credit card or personal loan is one that’s below the current average interest rate.

    You can find 0% purchase and balance transfer credit cards on the market. These often charge a higher APR once the interest-free period ends.

    Some credit cards will have higher APRs than the average. These are usually applied to credit cards that are issued to borrowers with poorer credit scores. It is always best to try to repay the balance of these credit cards in full each month to avoid having to pay high rates.

    Store cards often have added benefits but may have APRs that are much higher than traditional credit cards. Premium credit cards that offer large rewards on your spending often have higher APR rates too, and some will also charge an annual fee.

  • If you have a healthy credit score and a comprehensive credit report, you’re more likely to be offered the best APR rate. Lenders may charge higher APR rates to customers who they consider to be a higher financial risk.

    The advertised APR is there as a guide, but you may not be offered this rate. The exact rate will be confirmed for most borrowing when you’re successful in your application. But you can use an APR calculator to get an idea of how much you’re likely to pay monthly or annually.

  • Interest rate and APR are often grouped together but are two completely separate types of rates.

    The interest rate is the percentage charged on the initial loan. In the case of a credit card, that loan amount would be your card balance.

    APR is broadly the entire cost of borrowing money. It includes the interest rate plus other costs, such as lender fees, mortgage closing costs and insurance. If there are no lender fees, the APR and interest rate may be the same.

  • The APY is the annual percentage yield, and is different to the APR.

    APY stands for annual percentage yield, sometimes also known as EAR, or effective annual rate. APR measures the amount of interest you’ll be charged when you borrow, while APY/EAR is the measure of the interest you earn when you save. So, it only applies to the money you put into your savings account, not on money that you’ve borrowed.

  • AER is the annual equivalent rate and is the amount of interest you earn on your savings over the course of a year. Representative AER enables you to easily compare different deals when you are looking to open a savings account.

    An easy way to remember the difference is that APR is a cost (as you’ll be paying interest) and AER is a saving (as you’ll be earning interest).

  • A credit card’s APR is the total cost of borrowing money over a year. It’s made up of the interest rate plus any applicable fees every cardholder pays as standard, such as an annual charge. Other fees and charges, including missed repayments and cash withdrawals are not part of the APR.

  • Lenders will factor in your credit score, loan amount and income to calculate this fee. It’s then combined with the interest rate to give you the APR for the loan.

    A good rule of thumb when considering taking out a personal loan is that you should be comfortable with taking on a debt that's below 10% APR.

  • The APR for a mortgage is an annual percentage which shows the total cost of the mortgage, including the interest rate, bank fees and costs.

    A mortgage APR indicates the overall cost of borrowing across the whole term of the mortgage, provided the interest rate doesn’t change. But often this rate will change, either because you have a variable or tracker rate, or because you’ve decided to remortgage.

  • In most cases your account's APR will be advertised on the lender’s application page and is also displayed on your monthly credit card statement. The rate should also be displayed on the account’s online pages on the lender’s website and app.

  • A 0% APR is usually an introductory offer applied to a credit card. It means that you won't be charged interest on purchases, balance transfers or both, for a fixed period. Some other deals are available at 0% APR, such as car loans.

    It’s important to stick to the terms of borrowing and make all payments on time and in full, or you may lose the promotional rate early. Also, it’s best to try and pay off the amount you owe before this 0% period ends, or you may be moved on to a higher APR.

  • The APR quoted on a credit card deal is the overall cost of borrowing money over a year. However, there are some other factors you should consider too:

    • Monthly fees
    • Late payment charges
    • Benefits
    • Your credit rating

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