What is APR and how does it work?

By Laura Rettie, Personal Finance Journalist. Last updated 8th November 2023.

Laura Rettie

When you borrow money, you typically have to repay more than you borrow because of interest charges. APR stands for Annual Percentage Rate and explains the cost of borrowing money, helping you understand how much you'll need to pay back.

What is APR?

APR (Annual Percentage Rate) is the rate lenders use to help you understand the actual cost of borrowing. A lender must always tell you the APR before lending you money. 

You may hear “APR” and “interest rate” interchangeably, but APRs are technically slightly different. APR considers the interest charged and any additional fees, such as any setup costs or annual fees. It’s worth noting that APR only takes into account standard fees and not things like charges for missed payments or early repayment fees. 

APR shows the total cost of borrowing over a year, and it’s typically portrayed as a percentage. The higher the APR it is, the more expensive the cost of your borrowing will be. 

APR - personal loans

With personal loans, you’ll agree with your lender to repay a fixed amount over a specified period. The APR on a loan can be either fixed or variable. Fixed APR means that your repayments and interest will stay the same for the entire loan term. 

What is a variable APR?

Variable APRs can fluctuate throughout the loan term. This means that your repayments could be different every month. Of course, this does mean it could go down as well as up, which could mean the cost of your loan could be less. 

Borrowing over any time with a variable APR can be risky; interest rates could shoot up, and the loan could cost a lot more than you had initially anticipated. 

APR - credit cards vs loans

APR on credit cards demonstrates the cost of borrowing, provided you don’t incur any additional fees for things like doing a balance transfer, cash advances, or fees for late payment. 

The most significant difference between credit cards and loans is that they are a revolving line of credit, meaning you can borrow up to a certain amount, pay it off, and borrow it again, but you also don’t have to borrow your entire credit limit. 

In contrast, with loans, you borrow a lump sum and pay it back in instalments; if you wanted to borrow the same amount again, you’d have to apply for another loan. 

With credit cards, you’re only charged interest on an outstanding balance, so each month, you’ll be charged interest on what you owe; if your credit card balance fluctuates, so will the amount of interest you’re paying, even if your APR and interest rates stay the same.

What is a representative APR?

You'll find "representative APRs" in advertisements when searching for a loan or credit card.

The representative APR is a guide to the cost of borrowing for a ‘typical’ customer, meaning at least 51% of a lender's customers must get the representative APR for that product.  

It's important to note that the actual APR offered to you may vary based on factors including your creditworthiness and income. 

What is a personalised APR?

The purpose of a personalised APR is to provide an accurate interest rate that reflects your creditworthiness. Lenders may offer different APRs to customers based on a risk assessment. Generally, borrowers with better credit scores and lower risk factors will be offered lower personalised APRs. 

What is an introductory APR?

An introductory APR, or a promotional APR, is an interest rate offered by providers for a limited period at the beginning of a loan or for the first few months of using a credit card. Lenders use it as a marketing strategy to entice new customers to use their products over competitors. 

For example, a purchase credit card provider may offer no interest on purchases for the first 18 months, but after this period, you’d be charged interest on any balance left on the card. 

An important thing to remember about credit cards with introductory rates is that you need to stick to the card's terms. Sometimes you’ll lose your introductory APR if you don’t keep up with any minimum payments set out in the terms and conditions. 

What’s the difference between APR and AER?

APR (Annual Percentage Rate) represents the total cost of borrowing, and AER (Annual Equivalent Rate) illustrates how much you’ll earn from savings. 

AER represents how much interest you’ll earn over a year, and takes into account compounding interest, provided you leave your savings in the account.

What’s the difference between APR and APRC?

APRC (Annual Percentage Rate of Charge) is very similar to APR. APRC is used to demonstrate the annual cost of mortgages and secured loans.

Like with APR, mortgage and secured lenders are required to tell you the APRC before you sign an agreement. Mortgage lenders must display a representative APRC received by at least 51% of their customers when advertising the product. 

An APRC includes the interest rate but also takes into account other costs associated with a mortgage, such as valuation fees and broker charges, making it a useful measure to assist you in making an informed decision about whether or not a mortgage is suitable for you.

The information provided does not constitute financial advice, it’s always important to do your own research to ensure a financial product is right for your circumstances. If you’re unsure you should contact an independent financial advisor.