What actually is interest and APR? These terms go hand in hand with anything financial, so it’s very important to understand them! Here’s our quick and simple guide to understanding APR and interest.
Simply put: interest is a fee that a lender charges you for using his or her money. It is a percent of the amount you borrowed from the lender.
On the flip side, if you put your money into a savings account in a bank, the bank will pay you interest!
Like regular interest, compound interest is a percentage of the initial amount plus the accumulated interest of the previous periods. That’s quite wordy, so here’s an example!
If you put £1000 in a savings account that earned 5% interest, after one year you’d get £50, taking the total to £1050. At the end of year two you’d earn another 5% on your on your initial amount of £1000, but you’d also earn 5% interest on the £50 you got from year one. This gives you a grand total of £1102.50. That will continue for year three and so forth!
Essentially, this means your savings will grow more quickly because you are getting paid more interest over time.
Don’t forget, compound interest also affects borrowed money too, so the quicker you pay off a loan, the less you will have to repay!
APR stands for annual percentage rate, it is a percentage that is a calculation of the cost of a loan for the entire year. This includes the interest added and any other fees in relation to your loan, such as closing fees and participation fees. This way you can easily compare different financial options.
Payday lenders often have relatively high APR rates. However, it does not mean that you end up paying £1000’s on top of the original amount borrowed. Most payday loan companies require the loan to be paid back within six weeks or less, so APR is difficult to apply as it is not stretched over a year. Therefore, the APR is a better tool to compare loans that are taken out over a year or more.
How to use APR to your advantage
The good thing about the APR is that while some terms vary according to the type of loan, there is a legal regulation of APR within any kind of sector.
The Financial Conduct Authority (FCA) requires lenders to reveal your APR so that you can be able to compare each loan better. This law requires also lenders to tell you any finance charges you have to pay according to the selected loan and the complete amount you will have to pay is you meet all the requirements.