There is often a lot of confusion with interest rates or people think they know what rates mean but actually may not be correct. It is not surprising that we get confused though as lenders may try to confuse us so that the rates look more attractive than they actually are.
What is APR
APR stands for annual percentage rate and can be used to find out exactly what you will pay when borrowing. This is because it takes many things into account and not just interest. This can be confusing but it is an equivalent figure so it include the interest rate, any initial fees, loan costs and will take into account hen the interest is charged, as that could be yearly, monthly or even daily. Calculating this yourself could be tricky but as all lenders legally have to calculate it in the same way, then it is an easy way to compare products. There will be some charges that are not included in the APR, which could be because they are optional – so things PPI (Payment protection insurance) may be charged on a product but not included in the APR calculation. So it could be best when you are comparing loans to ask the lender if the APR includes all charges.
What is interest rate
The interest rate is the amount of interest that you will be charged on what you borrow. Some lenders will calculate it daily, others monthly, yearly or any time they see relevant. This means that comparing them can be tricky. As if you are charged per day and you are continuously repaying some of the loan, then you will only be paying for what you owe on that day. However, if it is charged yearly and you are repaying a bit each day, then the amount you get charged interest on at the end of the year will be a lot less. For example, if you owe £1000 and are charged interest on the last day of the year and repay £1 a day, then when you do get charged interest it will be on £1000-£364. However, if you get charged daily then you will get charged interest on £1000 on the first day and £999 the second day and £998 the third day and so on. This means that you will end up paying more interest compared with the first example. However, if you get charged your yearly interest on the first day of the year you will be paying it on £1000 and so it will be more expensive than the second example. So you can see why it can get really complicated and just having a interest rate percentage is not really that helpful.
Which to take notice
Therefore it is best to look at the APR to find out exactly what you will be paying and this will allow you to compare loans like for like. You will be able to see, at a glance, which will be more expensive for you. Then if cost is the only important factor in choosing a loan, you will immediately be able to see which will be the best for you to go for. However, cost is not necessarily the only thing you should be considering.
It can also be useful, for example, to find out what you will be repaying each month and compare that as well. Although this may vary a lot between loans, because they may have different expectations with regards to how long you have for repaying the loan, it will allow you to see how much you will need to make available each month. You may find that the cheaper loan has to be repaid more quickly and you cannot afford those repayments. It is worth checking to see as this could potentially cause big problems for you otherwise.
You may also want to consider other things such as the reputation of the company and whether you feel their customer services will be good. It may be that you will need to contact them or need them to help you and you will want to be sure that they will treat you fairly and efficiently.
So, if you want to find the cheapest loan then you will need to look for the one with the lowest APR. However, you will need to consider whether this is the most important thing to you as it could mean that you will end up using a lender that is not good to its customers, has a poor reputation and expects you to make very high monthly payments. This may not matter to you as long as you get a cheap loan, but others may be concerned about this and might want to consider their alternative options carefully. They might be prepared to pay just a little bit more if they can get smaller repayments or use a lender that they trust.