Or: why does my APR say 5000% when my lender says I repay 40 in every 100 pounds? Who’s right?
Answer: They both are.
Doesn’t make much sense right? Unfortunately there’s a lot of confusion around APRs so let us try and make them a bit clearer for you.
Back in the 1990s we had similar confusion over the advertising of loss-leading mortgage rates which shot up to the variable rate after the initial discounted period. Bearing in mind those were the days of plus 10% interest rates it was quite a shock to go from paying your mortgage at 2.99% to suddenly having to pay at 12%. APRs were brought in to reflect the overall cost of the mortgage payments over the course of a year rather than the upfront attractive headline rate thereby giving the consumer a fairer way of assessing the costs of their mortgage and comparing lenders.
Fast forward 20 years and we have a market where short-term high interest loans have replaced going to your bank and having an overdraft or small personal loan to tide you over. The problem with APRs is that they are there to reflect the cost of borrowing over the course of a year and not 3 or 6 months. In order to get to your APR the lender has to assume you’ve made your payments for the whole 6 months of the loan as required and then continued to pay your loan for another 6 months even though the loan has finished and you’ve paid it off!!
And that’s how you get a figure of 5000%.
Unfortunately we have a situation where we are comparing the price of eggs with the price of bread instead of eggs with eggs and therein lies the problem. APRs do a good job of giving you an overall view of the yearly costs of a loan like a mortgage of other longer term loan but when applied to the short-term loan market they over-exaggerate the already high cost of borrowing in this way.
As a general rule when looking at loans of less than 12 months, look for the figure which tells you how much of every £100 borrowed you will repay. There is your true rate of interest on the money borrowed.
We hope this helps.
Badger Financial
