A loan at 7% can cost you as much as one at 12%. How the APR works and how to compare loans.
Key findings
- The APR adds fees and mandatory costs to the interest rate.
- In the example, a 7% loan goes from a 7.23% APR to 8.93% with a 3% arrangement fee.
- With mandatory insurance of 15 a month, the APR reaches 12.45%.
Interest rate and APR: two different figures
The nominal interest rate is the price of the money you borrow: it is what the monthly payment is based on. The APR (annual percentage rate) adds what you really pay: fees and mandatory costs, and in Europe the effect of paying every month. That is why the APR is the figure for comparing loans with each other.
An example with numbers
A hypothetical loan of 10,000 at a 7% nominal rate over 48 months has a payment of 239.46 a month. With no costs, the European APR is 7.23%: slightly above the nominal rate because interest is paid monthly rather than once a year. You pay 1,494 of interest in total.
Now add a 3% arrangement fee. The payment does not change, but you receive 9,700 instead of 10,000 and still repay the same. The loan costs you 1,794 and the APR rises to 8.93%.
If the lender also requires insurance of 15 a month to grant it, you pay 254.46 every month. The total cost reaches 2,514 and the APR 12.45%: almost double the advertised rate.
| Loan of 10,000 at 7% over 48 months | Total cost | APR (European) |
|---|---|---|
| No costs | 1,494 | 7.23% |
| With a 3% arrangement fee | 1,794 | 8.93% |
| With fee and insurance of 15 a month | 2,514 | 12.45% |
Where the difference hides
- Arrangement or processing fees. Paid at the start, but they affect the whole term, and more so the shorter the loan.
- Mandatory products. Insurance, accounts or cards required to get the loan or a lower rate. If they are compulsory, they are part of the cost.
- Low payments over long terms. A longer term lowers the payment but raises the total interest. Always compare the total cost, not just the payment.
European APR and US APR
In Europe the APR is compounded: (1 + monthly rate)12 − 1. In the United States, the APR is usually the monthly rate times 12, so it comes out slightly lower for the same loan: 7%, 8.58% and 11.79% in the three cases above. When comparing offers, always use the same measure.
Work out the APR of any loan with its costs in the APR calculator, or the payment and interest in the personal loan calculator.