APR Explained

Due to the fact that Payday Loans are often repaid in less than a year, does APR reflect the true cost?

The Annual Percentage Rate (APR) of a loan is a representation of what a loan will cost you over one year. People can use the APR to compare loans from different providers. The lower the rate, the less it will cost in interest. The APR is shown as a percentage, which is relative to the amount you’re borrowing

But what if you are borrowing an amount of money for a period of time less than 12 months? Is APR the right metric to decide if a loan is expensive? We have answered some of the burning questions in the section below. This will hopefully help you decide if a product is right for you.

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If you’re borrowing £100 with 50% APR and repaying it over one year, then the interest payable on the loan would be £50. The £50 is in addition to the initial £100 you’ve borrowed. This means you’ll have to repay £150 over the 12-month period. However, the APR includes more than just the interest you’ll be charged. It also consists of any standard fees or additional costs (if there are any) the lender charges, making it a complete representation of the actual cost of the loan, rather than just an interest rate.

All reputable lenders are regulated by the Financial Conduct Authority (FCA). It’s a legal requirement for all lenders to show the APR on any marketing literature or information. This makes it easier for consumers to compare different loans from various lenders.

The annual percentage rate works well for traditional loans, where the borrowing is usually repaid over several years. However, payday loans are typically repaid over a much shorter term. This condenses the APR rate even if the cost is the same.

For example, if you wanted to borrow the previously mentioned £100 and had to repay £150, but the loan was only over three months, then it would be expanded to what you would pay over a year to work out the APR. £50 over three months would translate to £200 extra over one year. This makes the APR 200%, while you will still only pay £150.

This means APR isn’t always the best way to gauge how much a payday loan will cost you. Looking at the interest rate over a shorter period can be more useful, such as a daily or weekly cost per £100 borrowed. The real-world cost of a loan will be dependent on many factors. How much you borrow and the length of the repayment period being two of the most significant factors.

It’s easy to calculate the total cost of a loan by multiplying the monthly repayment by the number of months. This figure can be compared to the initial amount of the loan to see how much more you’re paying back than you borrowed.

It’s essential to make sure you can afford any repayments, as failure to pay can incur additional charges and interest.

Representative APR is a phrase many lenders use to try to give consumers an idea of what the average customer pays. To be able to use a representative APR, at least half of all their customers must pay that rate. While the rate will vary according to your circumstances and requirements, representative APR can be used as a gauge to judge how competitive a lender is.

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