APR Explained [Definition, Types, How to Calculate It]

Are you unsure what APR exactly means? Our guide will help you understand everything you need to know about an APR: what it is, how it works, the different types, and if you’re getting a good one.

What Is APR?

What does APR stand for? An APR is an acronym for annual percentage rate, representing the yearly interest charged on loans. Besides interest, an APR considers all the annual fees you need to pay if you’re approved for a loan. All lenders are legally required to tell you the APR of a loan before you borrow so that you can compare products and make an informed decision. In other words, an APR is the total amount of expenses per loan expressed as a percentage of the total loan amount yearly. (The APR is shown on the monthly statement you receive from your bank.)

So let’s say, for example, you owe £1,000 in credit card debt, with an APR of 20%. If you don’t pay off any amount of the debt you owe for an entire year, you’ll need to pay £200 in interest. 

How Does APR Work?

An annual percentage rate is secured on all loan types, including credit cards, mortgages, car loans, and other kinds of unsecured loans. Banks and lenders determine a specific APR for each loan and borrower. Before deciding the APR, the lender considers:

• Credit score
• Debt-to-income ratio
• Annual income
• Employment history
• Interest rate
• Loan terms

Once the lender has all the necessary information, they will determine the APR with compulsory charges. It’s essential to remember that specific fees (payment protection) are not included in the APR, as well as fines for late payments or exceeding credit limits. 

Good vs Bad APR

What does an APR mean regarding types? Different APR types can have good or bad APRs. For example, a personal loan with a 15% APR is cheaper than the same type of loan with a 17% APR. A low APR is naturally better than a high APR. 

One of the most common ways to incur more significant APR charges is to make only minimum monthly payments towards your loan, e.g., an APR on a credit card. If you make a minimum payment, you carry over the outstanding balance to the next month, and the lender begins charging interest.

APR Types

Different kinds of APRs depend on the credit the borrower applies for. For example, consider the following types.

Fixed APR

One APR meaning includes a fixed APR, which is guaranteed not to change or fluctuate during the life of the loan. This type of APR is best for budgets since your pay rate is predictable—making it easier to manage your finances.    

Variable APR

A variable APR changes with the interest rate index and may be based on the prime rate. If the prime rate increases, the variable APR will also increase. Even if the loan initially has a lower APR, the rate can increase in time, which is more difficult for budgets since you can’t predict the monthly payment. 

Introductory APR

One can’t fully define an APR without explaining an introductory APR. When you open an account, new credit cards can have lower APRs valid for a limited time—typically for purchases or balance transfers. After the specified period expires, the purchase APR transpires.

Purchase APR

The most common APR type is the purchase APR. The interest for this type of APR is based on the borrower’s purchases. All purchases are subject to a standard interest rate presented before applying for the loan or credit card. 

Cash Advance APR

What is the APR on a credit card? The cost of borrowing cash from credit cards has a significantly higher APR than taking money from other types of loans. For example, when you use a credit card for an ATM cash withdrawal, the cash advance APR applies to the total sum you withdraw.

Representative APR

What is representative APR? A representative APR is a rate the lender advertises when offering a loan. But not everyone who applies for a loan is eligible for this APR. Lenders, however, are required to give at least 51% of applicants the representative APR. So if you’re not among the 51%, you’ll be offered a higher APR loan.

Penalty APR

If you violate the terms of your loan by missing a payment or being late with your monthly payments, the provider can charge you a penalty APR. In such cases, the APR meaning for finance is an increased APR over time, typically when you miss two subsequent payments. In most cases, the penalty APR is 29.99%. Additionally, if you continue missing payments, the lender has the right to send you a county court judgment (CCJ) and request their money back via legal channels.

How Is APR Calculated?

Credit providers and banks use a specific formula to calculate APR and the annual interest rate and determine the interest rate you pay on your loan. The APR can be calculated daily or monthly—depending on the type of loan—but the bank or credit provider must first disclose how they calculate the APR. 

The size of the loan and borrowing period also play prominent roles in the APR calculation. Lower amounts typically come with higher APRs and short repayment plans. Conversely, the APR will be lower if you borrow a larger sum over a more extended period. 

How to Calculate Your APR

It’s easy to calculate the APR on your loan. Simply divide the APR by the number of days in the year (365) to get the daily periodic rate (DPR). Then, credit issuers multiply the outstanding balance by the DPR to determine the daily interest charge, compounded until repaid in full. 

What Is an APR on a Secured Loan vs Unsecured Loan?

A secured loan—typically backed by a mortgage or car—has a lower APR since assets serve as collateral. But with a mortgage APR, the lender calculates the interest rate, credit points, origination fees, and other expenses. As a result, APRs on mortgages tend to be lower than those on other loans. 

An unsecured loan doesn’t have collateral, so the lender must calculate a higher APR for a higher level of security. (UK lenders pay attention to the credit score when issuing unsecured loans.) 

So what is a good APR for a credit card or an unsecured loan? A percentage below the average interest rate is a good bargain, which is currently 20.77% at the beginning of 2022.

Key Takeaways

What Is a Good APR?

What is a good APR for a credit card in the UK or any loan? Unfortunately, there isn’t just one good APR for all loan types. Depending on many factors, an APR can range from 5% to 30%. As a general rule, the lower the APR, the better. In some cases, credit providers offer 0% APR on purchase and balance transfer credit cards for a limited promotional period—typically between three and 40 months. But if you don’t adhere to the specified terms, the promotional period could be cut short. 

APR vs APRC – What’s the Difference?

An APRC stands for annual percentage rate of charge. It’s essentially the same as an APR but used for comparing secured loans and mortgages. An APRC indicates the overall cost of borrowing, including broker fees and other expenses over the total loan duration, e.g., 20 to 30 years. Unlike the credit card APR meaning, an APRC is not customisable. If you’re not approved for a mortgage, you won’t be offered a different APRC on the same loan application. 

Lenders are required to tell you the APRC upfront. So when you’re applying for a mortgage, mind the following rates and fees.

1. Initial Interest Rate: This introductory rate is valid for two to five years before the standard variable rate (SVR) sets in.  
2. Variable Rate: When the fixed-rate period ends, the lender begins charging the SVR, which is higher than the introductory rate and unmodified unless the borrower remortgages.
3. Fees: These include the interest rate, arrangement, and broker fees. 

APRCs, for example, show the rate you pay on a mortgage if you don’t remortgage for the duration of the loan. Even though the APRC serves as an informative guide, the initial rate is the most important number you need to focus on since most borrowers remortgage once the introductory period expires.

Conclusion

Knowing what an APR stands for can be helpful when applying for a loan or credit card to make an informed decision about the best option available to you. The APR provides you with a bottom-line number to compare loans or credit cards and the annual fees you need to pay if your loan is approved.