What is an APR?

Tue, Apr 24, 2012

Financial Advice

The term APR is associated with any kind of financial loan be it a bank loan, car loan, overdraft, payday loan or any kind of loan from a third party.  Although most people at some point in their lives will take out a loan of some description, a surprising amount of people do not understand the term ‘APR.’  It is crucial to understand this term and the implications associated with it when agreeing to any kind of borrowing otherwise you could end up in more debt than you realise.

The term ‘APR’ is an abbreviation of the phrase ‘Annual Percentage Rate.’  It means the interest rate paid on an amount of money borrowed across an entire year.  For example if you borrow money at a 5% interest rate then it will cost you 5% of the sum of money that you agree to borrow i.e. £100 will cost you £105 to borrow for the entire year.  The most common type of loan is repaid in equal monthly instalments over the course of the year i.e. 12 months.  Therefore repayments would be:

£105 / 12 = £8.75 per month.

£8.75 * 12 = 105

This illustration shows how important it is to understand what APR is associated with a borrowed sum of money as it is the actual amount of money that you will be expected to repay from the loan.

Another good example is to look at the APR charged when taking out a payday loan, as initially looking at this type of financial product can seem very daunting due to their seemingly high rates.  For example, the average level of APR you can expect to be charged for this type of loan is in the region of 1737%.   Therefore to borrow £100 you would be charged 1737% of £100 to borrow this amount for an entire year.  This sound expensive however the nature of payday loans is such that it is meant a short term loan until next payday i.e. 28 days.  Therefore repayments would be:

(£100 * 1737%)/ 12 = £125 per month

In summary, it would cost £25 to borrow a sum of £100 for a period of a month, which is a much more realistic amount to borrow.

To conclude it is imperative to understand what APR means and how much APR is associated with borrowing a sum of money especially when it comes to direct payday lenders.  As long as you are aware of this and of how much you need to repay on a monthly basis and you are sure that you are able to meet these financial commitments, you are approaching the borrowing sensibly and should avoid spiralling debts.

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One Response to “What is an APR?”

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