If you are looking for short term loans, you might have noticed that the APR seems higher than for other forms of loans. We at cashasap.co.uk have put together this guide to help you understand APR, how to use it and whether it matters for your short term loan.
What is a Short Term Loan?
A short term loan is, as the name suggests, a loan that provides money over a short period of time, usually up to a few months, although it can vary. It covers two types of borrowing: instalment loans and payday loans. Payday loans are paid off within 1-35 days while instalment loans are paid off in multiple batches over a period of usually 1-6 months (although this is sometimes longer).
The key thing to remember as we discuss APR is that short term loans never last longer than a year and are usually significantly less. This impacts the way that APR should be considered in regards to this type of loan.
What is APR?
APR is an abbreviation of annual percentage rate. It’s a percentage number that calculates how much it will cost for the loan over the period of a year, including interest and any additional costs such as admin fees.
The most important thing to remember about APR is that it’s an annual rate. It measures the cost of borrowing money for a period of 12 months, significantly longer than the period of a short term loan.
If the loan were longer than 12 months, APR would be calculated by adding up the total interest and fees and then dividing to create a yearly average. When the loan is less than 12 months, the total cost is multiplied to give an average for the year.
This means that APRs for short term loans are usually much higher than APRs for loans that stretch for longer than 12 months.
Typical And Representative APR
You might also come across the terms ‘representative APR’ and ‘typical APR’. Every lender calculates APR using the same method because it’s a tool that a borrower can use to compare different loans. However, there are different factors that influence the APR that you will be offered on a specific loan as an individual.
Representative APR describes the APR which 51% (or more) of borrowers are offered, while typical APR describes the rate which over two thirds of borrowers are offered.
Lenders will usually provide better APRs to people to whom they’ve lent money before and know are reliable. This means that as a new borrower, you are more likely to be offered closer to the typical APR than the representative.
Other APR Terminology
You might have also come across other terms relating to APR:
Fixed APR: This is commonly seen with all loans, not just short term loans, it describes an APR where the interest rate is guaranteed not to change during the course of your loan (unless you fail to meet the loan requirements).
Variable APR: In contrast to fixed, this is an APR that might change throughout the period of your loan according to the financial situations happening in the world. You are much more likely to find this with credit cards and longer period loans than with payday or other short term loans.
Introductory APR: Usually found in relation to longer term loans and credit cards, introductory APRs are a lower APR than usual to attract new customers. These usually then return to a normal rate a certain amount of time into a loan or credit card use (but must last a minimum of 6 months, which is why they don’t affect short term loans).
Delayed APR: Again, this is one you won’t find in relation to short term loans. It describes a situation in which you don’t pay any APR for a certain period at the beginning of your loan but the APR then kicks in at some point further down the line.
Penalty or Default APR: If you break an agreement within your loan or credit card, usually a missed repayment, you then might get put onto a penalty of default APR which is higher than the usual rate.
Tiered APR: Usually seen with credit cards, it describes when different levels of borrowing are subject to different rates. For example, borrowing up to £1000 might have one APR while borrowing more than £1000 (the next tier up) might have an increased rate.
Why is my loan APR so high?
Short term instalment or payday loans are known for having high APRs. However, they come with the convenience of fast cash and don’t last a long time, which keeps the cost significantly lower than if the same APR applied to a longer lasting loan. This means that they often have a very high APR rate, but this won’t necessarily mean you’re paying very large fees.
It is also important to remember that the FCA regulations cap the interest on short term loans at 100% of the amount borrowed. This means that you will never pay more in interest and fees for your payday loan than the amount that you borrowed, irrespective of the APR.
(Although you should always be aware when choosing a loan that late repayments or failing to repay a loan could result in serious money problems.)
For example, borrowing £100 for ten days at an interest rate of 290% pa on a payday loan might translate as an APR of over 1500%. However, when it comes to looking at the cost of your loan in £ terms that high APR translates into less than £10 in interest and fees.
Compound vs Simple Interest
A lot of the issue with using APR to measure short term loans is due to the difference between compound and simple interest rates. Short term loans usually use simple interest while longer term loans use compound interest.
Simple interest is just calculated from the initial money you borrow.
Compound interest is calculated from the initial money you borrow, as well as the interest that adds up on it every month.
APR is a very useful tool for loans that function with compound interest as it helps to give you an idea of how much you’ll actually end up paying for the loan over a long period. Because it was designed for this, it’s less useful in regards to short term loans that use simple interest where there is an easy to predict payback cost.
So Does APR Matter On Short Term Loans?
APR matters to an extent and lenders have to tell you the APR of your loan by law. However, there are more useful tools than APR to calculate payday loan costs, work out if it’s affordable and to see if it’s the best price.
Instead of using the APR, it’s better with short term loans to look at the ‘total payable’ cost. This is the full amount of money that you have to repay. It is a precise and accurate way to see how much a short term loan will actually cost you.
If you’re looking for an instalment or payday loan between 1 day to 6 months, then cashasap.co.uk can help! We are an FCA authorised and regulated direct lender.
