What is APR? How APR Works

What is APR?

APR stands for ‘annual percentage rate’. It shows the full cost you would pay on credit if you took it out for a year (including fees and interest). It’s intended to help you compare credit facilities like overdrafts, credit cards and loans.

Interest confuses a lot of people. It’s not immediately intuitive whether it’ll be more expensive to pay 10% interest over two years or 2% interest over 10 years. It gets even more confusing when compound interest is added (where you pay interest on the entire amount owed, not just the original amount).

So, showing the percentage you could repay on an annual basis made sense. It simplified things.

Unfortunately, it confuses things more with short-term loans.

How high is the APR on Lending Stream?

Our loans have a representative 1333% APR (a representative APR means that this is the rate we expect at least 51% of people who are offered the loan will receive – whenever we talk about APR on here, we’ll be referring to the representative APR). This doesn’t mean you’ll repay 1333% of what you borrowed. If you were to borrow £200 over 6 months, you’d repay £386.61 in total. You can see a full example here:

Representative Example
Annual Interest Rate	292.0%
Total Amount of Credit	£200
Representative APR	1271%
Duration of Agreement	6 months
Total Amount Payable	£386.61
Number of Repayments	6
Each Repayment is	£64.44

Representative Example

Annual Interest Rate

292.0%

Total Amount of Credit

£200

Representative APR

1271%

Duration of Agreement

6 months

Total Amount Payable

£386.61

Number of Repayments

Each Repayment is

£64.44

Our loans are repaid over six months, so the APR shown takes our repayments and multiplies them (with compound interest) to show what it would cost over a year.

Why is the APR on payday loans so high?

If a loan is for a period of time shorter than a year, then the APR becomes more complicated. It has to be multiplied, at a compound rate, to reach the annual figure. And the shorter the time period, the higher the APR will end up being.

This can mean that a loan that is cheaper to repay in the short term can look more expensive than one that costs more over a longer period of time.

Here’s an example, used by Martin Lewis from MoneySavingExpert.com when talking to the treasury committee (you can read the original here).

If you lend a friend £20 and they repay you a week later, buying you a drink (£3) to say ‘thanks’, let’s consider that as a repaid loan with interest. What would the APR be on that loan?

According to Martin Lewis, it’d work out as 141,000% APR.

This isn’t because the amount you’ve repaid is ridiculous. But if you were to repay that every week and compound it, you’d end up repaying a much, much higher amount.

Do I pay the full APR on short-term loans?

Depending on how you define ‘short-term loans‘, you might do. If you consider a loan for one year as ‘short term’, then the APR will be what you repay. But if it’s for a day, week, month or a half-year, then you won’t pay the full amount shown on the APR.

In fact, there are caps on short term credit, meaning you can’t repay more than the amount you borrowed again. This includes fees as well as interest.

How do I compare APRs on short-term loans?

Each lender is required by law to display their ‘representative APR’. It can be difficult to compare representative APRs (see the first two questions for the difference between APR and representative APR) on short-term loans without knowing the length of the loan and the total amount you repay. If you know them, then it’s probably easier to just use those to compare the loans.

It isn’t just about the expense of the loan, incidentally. While a payday loan might be cheaper overall than a six-month loan, repaying the entire loan plus interest in one go may not be feasible. It may work better for you to spread the payments over six months, so your monthly finances aren’t impacted as much.

Consider how much you need and how much you can repay – if you were to repay the entire amount in one go, would that solve the issue or just put you in a worse position next month? Take a careful look at how much you’re repaying and whether or not you can afford it.

Does APR matter?

As an FCA authorised lender, we’re required to show the representative APR (see the first two questions for the difference between APR and representative APR). While it’s a useful measure, some people can sometimes find it more confusing than it is helpful.

If it helps you to decide which lender to go with, then that’s useful. If it doesn’t, then you should make sure you’re aware of the cost and repayment schedules of each potential lender, so you can make the right call.

If I pay back earlier, does that lower the APR?

It lowers the amount you repay, and lowers the amount of interest you actually repay. However, it can actually make the APR higher.

This is because the time period is now shorter, so the interest rate has to be multiplied and compounded more times to reach an annual percentage rate. In some cases, this will actually mean a higher APR, even if you pay less.

During the application process, you will need to show that you have a regular income and can afford the loan repayments. This will be verified in some cases, but this will be done discreetly.

APR and short-term loans