How to compare APR on a loan

Comparing APR on a short term loan seems like a relatively easy prospect, but when you realise that APRs don’t make it obvious how much a payday loan will actually cost, it can become much more difficult to use annual percentage rates as a measure.

Instead, there are other things that you can compare such as the interest rate per annum, sometimes noted as p.a., the total amount the loan will cost you and even things like missed payment fees. First and foremost, you should check to see if you could afford the emergency expense without taking credit to cover the payment, even if it means cutting down on your disposable income or invisible expenditure for the rest of the month. The cheapest way to cover an unexpected bill is with money you have earned, rather than money you have borrowed, so where possible, re-budget or consider starting an emergency funds pot for future financial shortfalls.

What is APR?

APR stands for annual percentage rate and all lenders must state their representative or typical APR on their websites. Annual percentage rate is a rate of interest which is charged for your borrowing over one full year. Usually, it only really becomes relevant if you are borrowing for 12 months or more, which is common in credit cards, overdrafts or even a personal bank loan. However, for short term loans, APR can be misleading because not only does it take compound interest into account, but it’s usually over 1000% which many find off-putting as you might think it will cost over £1000 to borrow a £100 loan.

Why is APR not always relevant to short term loans?

Although lenders must state the APR on their websites, it’s not necessarily the best way to compare short term loans. This is because a typical short term loan probably won’t last more than 3 months, so using an interest rate that compounds over 12 months isn’t going to give you an accurate view of how much the loan will cost.

Additionally, as you will make regular monthly repayments towards any short term loan, even if you did borrow for 12 months, the total amount you repaid would be much less than a representative APR of 1573% might have you believe, because interest is only charged on the loan principal, so as you make repayments, the loan principal is reduced and thus the amount of interest accruing also reduces.

Remember, that if you are struggling to meet your repayments you should get in touch with your creditor as they should be able to freeze your balance and arrange an alternative repayment plan. Failing to make your repayments on time or ignoring them because you can’t repay is only likely to make the situation worse and will affect your ability to obtain credit in the future.

What other measures are there to compare short term loans?

Measures like the total amount the loan will cost you can be much more helpful when comparing loans. When you start to make an application or use a comparison site, you should get a quote which tells you how much the total repayment amount will be and what your individual repayments will be (if you are applying for an instalment loan).

Additionally, looking at the interest rate per annum, e.g. 290% p.a., will help you differentiate lenders without causing too much confusion. A per annum interest rate tells you how much interest will be added across the year, but on a daily basis, and you can work out the daily interest rate by dividing the per annum interest rate by 365 (the number of days in the year), multiplying it by how much you are borrowing, and dividing by 100. It’s really not as complicated as that might sound! For example:

290 / 365 = 0.79

0.79 x £200 = 158.90

158.90 / 100 = £1.59 (rounded up)

So, if you borrowed £200 for 1 day, the daily interest would be £1.59 and so you would need to repay £201.59. Luckily for you, most lenders will have a loan calculator on their website which will work this out for you, so you won’t actually need to calculate the cost of the loan yourself.

In any case, as the FCA capped the daily interest rate at 0.8% for short term loans, you won’t see a per annum interest rate of over 292% anyway, and if you do, you should probably check if the lender is on the FCA register.

You can also compare things like the missed payment fees in case the worst happened, but you shouldn’t be looking at taking out a loan if you know you can’t afford to make the repayments.

Are there any checks I should do before applying for a loan?

You should make sure the lender is regulated and authorised by the Financial Conduct Authority (FCA). This ensures the lenders follow regulation like fair treatment of customers, and the price caps that were introduced in 2014 which stop you from being charged too much for your borrowing.

As with any product, whether it’s borrowing money or buying a lawn mower, you should check the customer reviews as well. This will help give you an idea of how the lender treats its customers that experience financial difficulty. You should never apply for a loan if you are already struggling with your current financial commitments. Instead we would suggest that you seek free and impartial debt advice from a charity such as StepChange or National Debtline. However we understand that anything can happen and it only takes one emergency expense to throw your finances off balance. In that unfortunate (and hopefully unlikely) instance, it’s nice to know your creditor will help in any way they can and not make the prospect of rearranging payments too daunting.

How can Clear and Fair help me compare short term loans?

Using Clear and Fair comparison site can make comparing short term loans really easy because we do all of the work for you. You just need to enter how much you are looking to borrow, and when you can make your repayment and we will list all the direct lenders who work with us that could provide you with what you’re looking for. We rank each lender from cheapest to most expensive, and we never promote lenders, so you will always know that the lender at the top of your search enquiry is the least expensive lender we host.