What is APR and how does it work?

The world of finance can be mind-boggling territory, so before you enter into any type of loan it’s really important you understand what you’re signing up for. Annual Percentage Rate (APR) is a term most of us are familiar with, yet many people are still left a little confused as to what it actually means in regards to borrowing. 

But fear not, we are here to help you! At Octane Finance, we want to make sure you’re up to scratch when it comes to the financial side of life. In this article dedicated to the topic of APR, we explain what it is, how it works and the different types of APR available. Read on to find out more… 

What is APR?

APR stands for Annual Percentage Rate and is used as a marker against the cost of borrowing. As such, APR refers to the yearly interest that’s charged if you are to borrow money from a lender. This amount gives the borrower a clear idea of how much they will be paying back over the agreed term of a loan. 

How does APR work?

APR can and will vary depending on a number of factors, including interest rate. In essence, APR is a percentage of the amount you borrow on a loan or credit card - the lower the APR, then the better rate you secure, whereas the higher the APR, the more you’ll end up paying back to the lender. 

Similar to interest rates, lenders must be completely transparent by disclosing what level of APR they charge to borrowers - this is agreed at the start of a contract. Be aware that credit card companies can adapt their APR rate on a monthly basis, but must be clear with the customer as to what the rate is before an agreement is in place. 

How is APR calculated?

Because APR is calculated on a borrower's personal circumstances, lenders will often advertise their rate as ‘from’ 12.5% as an example. The total loan amount and agreed monthly repayments both contribute to how APR is calculated. As such, APR can be calculated on a monthly or yearly basis.

Please bear in mind that banks use their own calculation formula to determine exactly how much interest you will pay back on any outstanding balance. Always check with the lender to confirm the going rate at any given time. 

How is APR determined?

The APR you’re offered can vary depending on your financial circumstances. Much like when you apply for a loan, your current credit score, credit history and any active credit activity can and will affect how favourable (or not) the APR available to you is. 

Even if you’re offered an initial low introductory rate, this can be subject to increases throughout the duration of your credit card or finance agreement. Late repayments or missed payments will result in the APR being increased.

What is the difference between fixed and variable APR?

Most of us are familiar with the terms ‘fixed APR’ and ‘variable APR’, but what’s the difference between the two? Familiarise yourself with the difference between fixed and variable APR so you can make an informed finance choice:

Fixed APR

If the APR is fixed, it means that the rate will remain the same throughout the loan period. Many people prefer their APR to be fixed as the rate stays consistent - which can make monthly budgeting far easier. 

Variable APR

If the APR is variable, it means the rate can fluctuate to increase and decrease throughout the loan period. While variable APR can offer a more attractive introductory rate, the likelihood is that it will increase over time, making it more difficult to plan your monthly budget.   

Are there different types of APR?

It’s worth noting that there are different types of APR - especially when it comes to credit cards. This is because there are various types of credit cards that you can apply for and how it is used can affect the rate offered too. We explain the different types of credit card APR, below:

Cash Advance APR

When you borrow cash from your credit card, there is a fee attached with every transaction. This is known as Cash Advance APR. 

Introductory and Promotional APR

When you apply for a new credit card, it’s likely you’ll be offered a limited-time lower APR as a new customer - this is known as Introductory or Promotional APR.

Penalty APR

If you don’t meet the terms of your credit card agreement - such as a late or missed payment -  then the APR rate could end up being increased for a short period of time. This is referred to as Penalty APR.

Purchase APR

When you purchase items using your credit card, then Purchase APR will determine how much you pay back on top of the product cost.

So you can thoroughly understand just how much you’re paying back on the credit card at any given time, always stay up to speed with the going APR by regularly checking your account and monthly credit card statement.  

What is representative APR?

Representative APR is a phrase that’s advertised on a website or literature associated with any company or product that offers finance solutions. In most cases, loans are ranked by their own representative APR which makes them easily comparable when ‘shopping around’ for the best finance deal. 

In essence, representative APR quite literally ‘represents’ a higher number of borrowers - so at least 51% of people will need to receive the same rate (or lower than) for it to be advertised as representative APR.  

What is personal APR?

Personal APR  is one that is in fact ‘personal’ to you and your circumstances. Before a personal APR is offered, your current financial situation, credit score and credit history will be considered against how much you wish to borrow. 

What is exact APR?

Exact APR pretty much does what it says on the tin - the rate you’re advertised is the ‘exact’ rate you’ll be given. This is helpful if you have a strict budget to stick to, as many loan companies may only be able to offer an APR ‘from’ a certain rate. With exact APR there are no hidden charges to worry about.    

What is a good and bad APR

When searching around for finance, you’ll want to find a favourable rate. In recent years, the average APR has been gradually increasing in line with the rate of inflation, but generally you’ll be able to find rates that vary between 5% at the lower end and 30% at the higher end. 

As such a ‘good’ APR will always be a low rate of interest, whereas a ‘bad’ APR will be a high rate of interest. The lower the APR number, the better deal you’ll receive. But let’s be realistic, given the current circumstances during the cost of living crisis here in the UK; data from the Bank of England shows that the average interest rate on a credit card was 22.2% APR. 

22.2% APR on a credit card is higher than the average rate during the previous year, but of course this will vary depending on your personal financial circumstances. In the current market, if you can source an APR anywhere in the region of 9.9% to 18.9% then this is to absolutely be considered. 

From data compiled by financial research specialists NimbleFins, we know the following information relating to average credit card APR depending on whether you have good or bad credit:

What is APRC?

When you apply for any form of finance, the lender is required to provide you with a quote which includes the APRC too - this stands for Annual Percentage Rate of Change. Designed to help you compare the true cost of borrowing, the APRC will reflect the total amount of interest due to be paid throughout the lifetime of the loan.  

What is APY?

With so many financial terms flying around, it’s easy to get confused. One common example of confusion is the difference between APR and APY - which stands for Annual Percentage Yield. Here’s the distinct difference between the two:

• APR is a measurable amount of interest you’ll be charged on top of what you borrow from a lender, bank or credit card.
• APY is a measurable amount of interest you’ll earn when you save money by putting it in a savings account. 

How is APR calculated for a car loan?

As with any loan, APR on car finance is calculated in exactly the same way. The APR you’ll pay against a car loan is the cost you’ll pay to borrow that money from the lender. Whether fixed or variable, the rate will depend on your financial situation and current economic conditions. 

Here at Octane Finance, we can source car finance solutions from 9.9% APR and zero deposit deals representative APR of 15.9%. Over 80% of the car finance deals we secure for our customers don’t require an upfront deposit, so it’s certainly an option to consider.  

Access a finance calculator

If you’re looking for affordable finance to purchase a new or used car, then why not find out how much your monthly payments might be. You can use our handy free online calculator to work out the cost of a Hire Purchase (HP) or Personal Contract Purchase (PCP) deal on your next vehicle.    

Secure vehicle finance at an affordable APR

When comparing a personal loan for a car to the funds made available through a credit card, then it’s definitely worth highlighting that a credit card’s APR is usually higher than applying for finance through a lender.

We work with a huge range of lenders to secure you the best rate of vehicle finance. As a leading broker operating within the automotive industry, our car finance experts are perfectly placed to help you make an informed decision. Fuel your car finance by contacting us today.