02 October 2019
APR, or the Annual Percentage Rate, is a term you’re probably familiar with if you’ve been looking at taking out a short term loan; but you might not know exactly what it is, and what it’s used for.
What is APR?
APR is the universal measure for comparing the price of all financial products; things like mortgages, credit cards and, of course, loans. For loans that are under 1 year in duration, like buffa’s short term loans, a loan’s APR represents the total cost of taking out that loan over and over again for a year, (including any normal charges) and borrowing more and more each time to pay off the last loan in full. Or to put it more simply, what the loan would cost if taken out for an entire year.
It’s a legal requirement for loan providers like us to show our APR on our site; for complete transparency, and so that people understand how much they will be repaying.
It’s very important to Keep in mind that a high APR doesn’t always mean that you’ll be repaying a small fortune; it’s simply a measurement for comparative purposes!
Fixed & Variable APR: What’s the difference?
There are two main rates of APR- fixed and variable. A variable rate of APR reflects a price that changes; based on national rates or any wider economic changes. For example, it is common for homeowners to get a mortgage rate that is fixed to the Bank of England’s Base Rate. This means that if the base interest rate goes down, they should end up paying lower mortgage repayments as their variable APR rate associated to their mortgage should also fall.
A fixed rate of APR means that the rate charged won’t change at any point during the term of the financial agreement. For example, all short term loan providers have a daily interest rate of 0.8% per-day or less which is completely fixed and will not change. The only addition to this interest charge being if a customer falls behind on their repayments and is required to pay late or missed payment fees.
Representative apr explained
The representative APR is the rate that the credit provider by law gives to at least 51% of their customers. For short term loans offered by lenders like buffa, this would typically be the representative APR in the given repayment examples.
Most lenders are required to provide a repayment example, which highlights how much interest will be paid, on a certain amount of capital, over a set amount of time. This can provide a more practical example of how much your loan will cost than the more simplistic representative APR figure which can be a very misleading representation of the actual cost of repayment for a credit agreement.
Why is the APR so high for our loans?
The APR for short term or payday loans tend to run into the thousands of percent; a figure which is understandably eye-catching, but also potentially very misleading.
A short term or payday loan will only typically last for between 4 and 12-weeks, and often much less time than that if customers repay earlier. However, to express the cost of such a loan as an Annual Percentage Rate, the interest is compounded (or added again) over and over, over the course of a whole year to show what it would cost if the loan were being taken out for an entire year – even though we know this is never the case with such loans.
The consequence of these APR calculations over a whole year is to make the representative APR for such short terms loans as offered by buffa to be much higher than in reality they ever could be.
With a buffa loan, you of course can never be paying back thousands of pounds in interest, and if you can repay earlier than the initially agreed life of your loan, then you save money on the overall interest charges associated with the loan.
What factors can affect APR?
The different factors that can affect the rate of APR include the loan term, the financial situation of the borrower, and the rates offered by the credit provider.
In the case of a short term loan term, if a loan only lasts for a few weeks or small number of months, as previously described it will still be calculated as though it is open for a year. Since it will be multiplied again and again, it could lead to an APR that runs in the hundreds or thousands of percent.
Whether the loan is secured or not will also affect the rate of APR. The Annual Percentage Rate for mortgages tends to be quite low, at typically less than 5% per year, because the loans are secured on the individual's home or property which can be repossessed by the lender if they cannot meet their repayment requirements.
By contrast, a short term loan is unsecured, and the borrower does not put anything down as collateral or security against the cost of the loan and as such this is reflected in a higher rate of APR for such a loan.
The borrower's financial situation will also have an impact on the rate of APR that they have been given. For applicants with poor or impaired credit history, the provider may need to charge a higher rate of interest to manage the risk of the borrower defaulting against that credit arrangement – this in turn making the APR higher.
Equally, if a customer has a good credit rating, the APR may be lower because they are considered much less of a credit risk to the lender.
At buffa, we can offer loans even if you have a poor credit rating, and we pride ourselves on treating each individual case with the same level of both care and understanding; if we don’t think you are in a strong enough financial situation to take out a loan, we’ll be honest with you and we won’t accept your application.
Loan and credit providers of course ultimately largely have the choice of how much they wish to charge for their products and services. Some sectors such as short term loans have a maximum daily rate of interest (or price cap) associated to their product, but such lenders will still have different rates of daily, monthly and ultimately yearly APR depending upon their competitiveness, risk appetite, and other features associated with their individual products.
Hopefully this article has helped in explaining what an Annual Percentage Rate is, the factors behind the often very misleading numbers, what the different types of APR are and what they mean for you in the context of credit services you may be using now or in the future.
Representative Example: £100 over 3 months at 274% p.a. (fixed), repaying £49.52 per month totalling £148.56. Representative 1087% APR.