Whether you’ve borrowed before or you’re looking for your first personal loan, the differences between interest payments, APR and the Representative Example can be confusing. If you’re struggling to know how best to conduct your search for credit due to these grey areas, then you may not end up with the best loan for you and your particular circumstances. This can increase the risk of defaulting on the loan payments, which is stressful and can damage your credit rating.
Research carried out by Shawbrook Bank this year has found that APR, interest rates and representative examples are not always giving the customer a clear picture of the product, or how much they will actually pay once the loan is approved. While it’s a concern that many banks are advertising misleading rates for their loans, it’s important to remember that with knowledge comes power. If you know the jargon and you know where you stand when it comes to obtaining credit, then you have the power to avoid misleading information.
Read on for H&T’s comprehensive and easy to understand guide on interest rates, APR and the Representative Example. What are they exactly, how are they related, and how to do they affect your loan application?
What is interest?
Interest is a simple concept, but it can be made to feel a lot more complicated than it actually is. When you borrow money from a lender, you are expected to pay that money back within an agreed timeframe. The money that you pay back will be more than you borrowed, and this extra money is essentially a payment for the lender’s services. It covers their business costs and allows them to make money on the transaction, which is of course necessary for businesses of all types. This extra amount that is paid on top of the loan amount is called the interest.
Interest is usually shown as a percentage of the total amount borrowed. This figure can be very low – in the single digit area – or it can be very high, depending on the applicant’s credit score, the type of loan and the amount being borrowed.
What is the APR?
When you’re looking at borrowing money, the piece of information which can tell you the most about how suitable a loan is for you is the APR - which stands for Annual Percentage Rate. You’re likely to see it everywhere when searching for credit and it’s important to know what it means.
The Annual Percentage Rate is simply a way of measuring interest in a more meaningful way. Essentially, APR is the amount of interest you will pay on your loan over the course of 12 months. The figure is shown as a percentage of the total amount borrowed, and it also includes any additional fees and charges which may or may not apply depending on the lender.
What is a Representative Example?
The Representative Example is a breakdown of the costs of a typical loan amount and term from that lender. It will show the rate of interest and any fees as APR (applied on an annual basis). The total amount to be paid back is also included by law, which shows the loan amount plus the interest and fees over the full term.
The Representative Example exists to give potential customers a good idea of how much they’d pay back when borrowing an average amount at the representative APR. It’s a handy piece of information to look back on when comparing loans from different lenders, as it gives a much simpler, wider picture of what is on offer.
What customers should be wary of, however, is the fact that the Representative Example is just that: representative. The approval of your application, the amount you may be offered and the amount of interest you pay can change from what is advertised depending on your credit rating, your circumstances and if you’ve borrowed from that lender before.
Will I get the advertised rate?
The representative APR must, by law, show what at least 51% of customers will pay for their loans from that particular lender. This number may seem low, and it can come as a surprise to many when they find out that they do not qualify for the advertised rate. This can be down to the applicant’s credit score being lower than anticipated, it could be because it’s the first loan a customer has applied for, or it could simply be down to the applicant’s behaviour as a previous customer.
However, it’s worth noting that 51% is a minimum figure and many lenders will achieve a higher percentage of loans under these terms. What’s more, not qualifying for the advertised rate may be the result of your credit score being better than the lender’s threshold. This means that you could be offered a lower rate and therefore pay less overall for the amount that you borrow.
How do I know where I stand?
There’s no way of knowing for sure whether you’ll get the advertised rate on a loan prior to your initial application, but there are ways to get a feel for where you stand. Check your own credit score prior to making any applications. Many credit reference agencies will show you examples of the type of lenders which are most likely to lend to you. This is a good way to get some clues, and to see what kind of APR you’re likely to achieve.
When you apply for a loan, the lender will give you the chance to review the full and final costs before you sign on the dotted line. It’s important that you’re happy with what is offered, and it’s perfectly fine to decline the loan at this stage. Just keep in mind that, when you make an application, this can show up on your credit file whether you are approved for the loan or not. Too many applications within a short timeframe can have a detrimental effect on your credit rating, so be sure to do your research and don’t be afraid to ask up-front questions about your suitability.
Learn more about H&T’s personal loans here, or pop in-store for an informal chat with a member of the team.