What is an annual percentage rate (APR)?

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

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