Loans, credit cards and mortgages are serious agreements

Loans, credit cards and mortgages are serious agreements for anyone to enter into but most people will admit that it is the APR that strikes most fear into prospective borrowers. The reason is simply that it is next to impossible for the lay person work out what exactly it is.

After all, it is not the same the yearly interest rate quoted, and so what the APR composition is, leaves almost everybody confused. So, here are a few facts that may help to clear the mystery up.

APR versus Interest Rate

Simply put, it is the annual percentage rate that more accurately reflects the actual additions to the principal sum that a borrower will have to pay. In this, the figure can be slightly higher than the flat interest rate. And this can be what gives the rate such a bad reputation. But there are good reasons for the difference.

For a start, the APR composition represents all the additional expenses associated with the loan. A major part of this is the paperwork and administrative services that go into calculating, organizing and preparing the loan agreement.

For example, the underwriter that the works out the risk assessment needs to be paid, as does the secretary who types out and prints the loan agreement. Sometimes, an application fee is also included.

Some lenders also include more speculative charges, such as insurance against losses should the borrower die suddenly and leave the loan unpaid.

So, when a consumer looks at the APR beside the loan advertisement, this is the figure that matters. The interest rate per year, meanwhile, simply refers to the interest charged on the principal sum borrowed, and nothing at all of the added costs.

Different Kinds of APR

Perhaps the most confusing aspect is that there are a number of different types, especially when it comes to the actual method of calculation. The annual percentage rate, for example, can be fixed or variable, with the former meaning that the rate does not change over the course of the loan, and the latter allowing for fluctuations in general interest rates at different times. So, if rates fall in general, that is good for the borrower, but if the rates increase then their repayments will increase too.

This is different when talking about credit cards, which reserve the right to change interest rates even when the rate is fixed. With a fixed APR, the credit card company must issue a warning to customers 45 days in advance of any change.

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