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How is the APR of a loan calculated?

The APR on a loan is the Annual Percentage Rate, which includes the cost of borrowing the money along with any fees that are included, such as an arrangement fee. All loan providers have to declare the APR that you will be charged, which varies from lender to lender, before you sign your agreement.

So, let us look at a couple of examples:

If you borrow £10,000 over 4 years at a fixed APR and annual interest rate of 6.3%, then your repayments would be £235.42 per month. Your total charge for credit would be £1,300. This would mean you would repay £11,300 in total for your loan.

By taking out the same loan over 5 years, but at an APR and annual interest rate of 14.9%, your repayments would be £193.91 per month. Your total charge for credit would be £1,635 and you would repay £11,635 in total for your loan.

Calculating your APR can be a little bit confusing. There are online calculators that will do the sums for you. If you would like to roughly calculate it yourself, then take the advertised APR and divide it by 2 to give you the base rate. Now, multiply the base rate by the number of years you would take the loan over.

So, let us look at a loan of £6,500 over 4 years at 7.2% APR.

7.2 divided by 2 = 3.6 base rate multiplied by 4 years = 14.4%.

£6,500 x 14.4% = £936.

Therefore, the total repayable would be around £7,436. Divide this total by 48 payments, which is the total number of payments made over 4 years. This would make your monthly payments about £154.92.

This may differ from online calculators and the sums given by the lender as it does not include any extra costs, like arrangement fees that are added to the loan amount before the APR is calculated.

For example, if you had a £100 arrangement fee on top of your £6,500 loan, then your APR would be nearer to 7.99%. Your monthly payments would change to £158.66. The total interest you would pay would be £1,115.60, bringing your total loan cost to £7,615.60.

Therefore, when considering the APR of a loan, it is best to check the total amount payable on the borrowing, as well as the lending rate for comparison between lenders.

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