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What is APR and how does it work?

What is APR and how does it work?

If you’re going in for any type of personal finance – where you are borrowing money from a lender – then APR will usually be mentioned. It’s particularly pertinent in the automotive scene, where all Hire Purchase (HP) and Personal Contract Plan (PCP) deals involve APR and, if you otherwise go to a bank and borrow, say, €10,000 to buy a used car, then you’ll be paying APR on that €10,000 too. But what does APR mean and how does it work?

What is APR?

APR stands for Annual Percentage Rate, and it’s the official rate that helps you understand the cost of borrowing. In the simplest terms, if you were to borrow €100 at a rate of 8 per cent APR over the course of one year, then you would pay around €8 interest on that loan – so you would borrow €100 and pay back €108. All credit lenders are legally obliged to tell you what their APR figure is before you sign any paperwork, but be aware that any charges pertaining to the loan (arrangement fees etc.) are included in the amount you borrow, affecting the interest amounts.

How does APR work?

The example above is a little simplistic, because each monthly repayment you make on a loan with APR will contain a larger portion of capital repayment and then a smaller portion of interest payment. That means that the amount you still owe (the loan capital) starts reducing from your first monthly repayment, but that a portion of your repayment is servicing the APR interest. As you make more repayments, then the capital reduces quicker and the amount of the interest portion of your monthly repayment becomes smaller.

What is a low rate of APR and how do I lower my APR?

APR varies on car loans but is typically in the 6-9 per cent bracket. When car-selling promotions are on, you find some manufacturers will do HP or PCP deals at rates of 1.91 or 3.9 per cent, for instance. One way of lowering your APR is, conversely, to borrow more money, as lenders will offer lower interest on bigger or longer-term loans.

Can I calculate my interest payments using APR exactly?

You can, but it can become a little complicated, as you need to work out how the interest portion of your repayment reduces month on month, relating to the reduction in capital. It becomes particularly difficult on credit cards, where different APRs apply to different types of transaction (balance repayments, money forwarding, purchases etc), but that’s a story for another day. In essence, APR is just there as an easy-to-grasp figure that indicates how competitive a particular loan is. In plainest terms, you will pay less on a 48-month, €10,000 loan at 15 per cent APR than you would on one at 17.5 per cent APR.

Carzone - 14-Jan-2019