APR calculation explained
The APR calculation can vary between lenders but is normally calculated by using the interest rate, booking fee and any arrangement fees.
The APR can be affected by any special incentives offered by the lender, for example discount periods or cash back offers, and will vary depending on whether interest is calculated daily or monthly.
The APR calculation should provide a clear indication of the total annual cost of credit over the lifetime of a loan. Sometimes the APR is given as a monthly rate so we've created an APR to monthly calculator which should help you make a comparison to the annual figure
APR calculation example
A lender can make a loan appear attractive by quoting a low initial headline rate for a 25 year mortgage. For example an interest rate of 2.5% fixed for the first 3 years can seem a good deal to a potential borrower.
The additional costs not reflected in the headline of the mortgage above rate may include a £995 application fee, £595 valuation fee, and early repayment charges of 5% within a 3 year tie in period. Once these costs are identified the headline rate begins to look much less attractive.
The APR is designed to take into account these extra charges and could be more like 5.9% compared to the 2.5% headline rate initially quoted by the lender. The APR calculates the cost of finance as an average rate of interest over the 25 year term of the mortgage.
When advertising loan products, a lender will often quote a "typical APR".
Many lenders set the actual interest rate charged according to the borrower's credit record and financial background, so the APR can vary significantly for different applicants, and can be much higher than the typical APR.
Overall the typical APR quoted should be available to at least two thirds of potential customers, so this will need to be taken into account before a lender publishes their figure.
If in doubt please speak to an Independent Financial Adviser who can provide impartial advice.