What is the difference between APR and interest?

Applying for loans and working out which is the best for you can be time consuming. There are many different variables to consider, such as the length of the loan, the amount you’re borrowing, the policies of the lender, and the APR and interest rates.
Lenders will quote you figures and percentages, but how often do you actually think about what these numbers mean?
It is important that you understand what interest and APR actually are and how they relate to you. It’s especially important when you’re taking out a loan of any kind, but even if you’re not it pays to be savvy about these things.

What are interest rates?

A country’s official standard interest rate is set by a financial body – for example in the UK it’s the Bank of England. The Bank of England sets the UK’s interest rate, taking into account economic factors both national and global. This standard rate is then used by lenders to determine what rate they are going to charge borrowers – but they don’t just charge you the standard interest rate. More goes into it than that. The interest rate you will pay on your loan can also be determined by risk. The lender will assess the risk of lending you money, and offer you an interest rate based on this.

To do this they’ll look at your credit profile to get an understanding of your previous history with managing debt and making payments on time. Responsible lenders will also look at your current situation, such as your employment status and income, to assess whether you’ll be able to keep up with the repayments.

If they deem you to be a high risk – or the loan they’re lending you is particularly risky – they’ll offer a higher rate of interest to protect themselves. This is so that if you only make a few payments they will have recouped more money through interest and won’t be so out of pocket. It is also intended to encourage and reward good borrowers, who make their repayments on time all the time and manage their finances effectively, and to give people with bad credit histories and impetus to improve their profile first rather than getting into more debt.

How is this different from APR?

Looking at the interest rate of a loan only shows you how much interest you’ll pay on top of the loan. You might also have other charges and fees to pay, and the APR includes all of these. It stands for Annual Payment Rate and it shows you what you will pay on the loan over the course of a year. It’s much better to use APRs when you’re comparing loans. Remember though that online calculators and quotes might not give you an exact figure, as they could be an estimate rather than based on your personal circumstances. Always find out what you’re own rate will be before you accept a loan or credit agreement.

High interest loans

Recently many high interest loan companies have flooded the market. These lenders often offer instant transfer into your account and very little in the way of qualifying questions. Some don’t even check your credit history, they just want to know that you’re going to repay the money.

This might seem like an easy way to get cash but it can be very damaging. As I said earlier, a high interest rate is caused by high risk, and these loans are inherently risky. Sold as a way to plug a gap in your finances until payday, they’re usually for relatively small amounts, with repayments spread over, say, 6 months. The problem is if you need this short term fix in the first place you might not be in the best position to meet the monthly repayments. If you owe £500 and you miss a payment of £90, you don’t just still owe £500. You owe that plus the extra interest – and when that interest rate is several hundred percent the £500 can quickly escalate into a lot more. Your repayments increase as you miss payments making it harder to catch up.

The loans are generally unsecured as well so lenders will employ bailiffs to recover the debt by taking away your possessions.
What seems like a small quick cash fix can end up costing you thousands of pounds and borrowing from these lenders is generally bad for your credit profile. You’re better off tightening your belt and saving for a few months – in the long run you’ll have more cash.

Secured Loans

Secured loans like car credit, mortgages or other forms of credit secured on your property or possessions can often give lower interest rates. This is because the lender knows that they have something tangible that they can recover if you become unable to repay the loan. For example if you enter an agreement with a car finance company for credit to buy a vehicle, technically the lender owns the car until you’ve repaid the loan in full. Because the finance company owns an actual asset as a result of lending the money, it’s much less of a risk for them. The risk for you, of course, is that if you stop repaying them they can repossess the vehicle.
Interest rates and APR on secured loans will still be based on your credit profile and ability to repay, though. Some companies are happy to lend to applicants with poor credit, but responsible lenders will always look into your current circumstances and ability to repay.
Usually, you can lower the amount you’ll pay each month by lengthening the term of the loan, but be aware than longer loans usually have a higher APR so you’ll end up paying more in the long term.

There are many different types of loans and lenders on the market, with a huge variety of interest rates and APRs on offer. Never take a loan offer at face value – make sure you understand what the APR is so you can get an idea of how much you’ll be paying in a year. Also look into are there any hidden charges; can you afford the monthly repayments; how long are you committing to the loan for? If the company seems unwilling to give you all the information, don’t borrow from them.

Kat writes about personal finance, loans and lifestyle topics, giving advice about borrowing and budgeting for Car Loans for you.

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