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Managing my money for young adults
Managing my money for young adults

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5 Annual percentage rate of interest (APR)

This is a photograph of a car with ‘0% APR’ written on the windscreen.
Figure 5

You’ve seen that borrowers have to repay to the lender both the principal sum and the interest. On top of this there are often extra costs. Some come from fees when you get a loan in the first place and others, in certain circumstances, arise if you repay the loan before the end of the term.

  • Arrangement fees paid to the lender: usually flat-rate, one-off fees charged when the loan is first taken out. Sometimes they might be added to the loan.
  • Intermediary (broker) fees: might be paid when a borrower does not deal directly with a lender but deals instead with a broker.
  • Early repayment (or ‘pre-payment’) fees: might have to be paid to a lender if a loan is repaid early. The argument used by lenders is that earlier repayment can incur additional costs. In the case of personal loans, early repayment charges mean the lender gets a share of the interest that would have been paid had a borrower kept the loan for the full term.
  • Tied insurance: taking out insurance (for instance, payment protection insurance, life insurance, home insurance) might be required with a loan. In other cases, insurance might be optional, although this is not always made clear to borrowers, who might end up paying for inappropriate policies.

Given all these different potential charges, and the different methods of calculating interest, it’s important to have a good means of comparing the total cost of debt on different debt products. Fortunately, in the UK there is a way of ensuring a fairly accurate ‘like-for-like’ comparison and of assessing which debt product is most appropriate. This is known as the Annual Percentage Rate (APR) of interest.

The APR includes interest and those charges that are compulsory. It does not include:

  • optional charges, such as buildings insurance, that are not required as part of a mortgage package
  • ‘contingent’ charges, such as early repayment fees, that depend on certain circumstances and that would become payable only in situations that are not applicable to all lenders.

The APR also takes into account when the interest and charges have to be paid. Generally, a low APR means lower costs for the borrower. You will see the APR set out in posters and other advertisements for debt products, helping consumers to make comparisons between them.