What you need to know about APR

APR stands for Annual Percentage Rate. It’s a formula set by the Office of Fair Trading and ensures all published APR are calculated in the same way.

Essentially an APR tells you how much interest you will pay on a loan in a year. It can be used to work how much the total cost of a loan will be. It helps you compare one loan or credit card against another.

When you see the words ‘Typical APR’ on an advert or application it means that two-thirds of applicants are guaranteed to get this rate. If you find yourself in the other third, you could be paying much more!

Credit card and loan APRs can vary significantly according to your credit status – usually, the better your credit score the lower your APR. It is often worth ensuring your credit file is accurate before getting out a loan because of this.

Now for the mathematics of APR. Sorry.

If you borrow £100 at an APR of 10% you will need to repay £110 at the end of of the year.

However, we usually borrow money for more than a year so at this point you will pay interest on the interest charged over previous years. This is called compound interest.

A two-year loan at 10% will mean that you pay interest of £10 after year one as in the example above. However after two years you will pay £10 from year 1, £10 from years two and 10% interest on years 1’s £10 interest - £1. The total interest after 2 years is £21.

This carries on and on with your debts accelerating the longer you have them.