7.1 Annual Percentage Rate (APR): the key comparator for borrowing decisions
You’ve seen that borrowers must repay to the lender both the principal sum and the interest. On top of this there are often extra costs. Some come from ‘arrangement’ fees and intermediary (broker) 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.
Given these different potential charges, and the possible differences in the timing of repayments of borrowed money, it’s important to have a good means of comparing the total cost of debt on different debt products. Fortunately, there is a way to create like-for-like comparisons and assess which debt product is most appropriate. This is known as the Annual Percentage Rate (APR) of interest. This takes into account not only the interest rate charged on money borrowed but also when, and how often, interest is paid during each year. The APR also takes into account any other compulsory charges that are contractually part of a loan agreement.
While useful with loans and credit cards, an APR as a comparator is not infallible. On mortgages, for instance, it assumes you stick with that mortgage provider for the full term and pay the standard variable rate when an introductory rate ends. The reality is many people never pay that standard rate – as they tend to switch mortgage before it’s charged - so there is little to be gained from comparing a mortgage cost over 20 years or more.
Note that APR does not include:
- optional charges, such as buildings insurance, that is not required as part of a mortgage package (though you don’t need to get it from your mortgage provider).
- ‘contingent’ charges, such as early repayment charges, that depend on certain circumstances and that would become payable only in situations that are not applicable to all lenders.
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.