Extramile Finance

Before taking a loan, compare the interest rate, APR, monthly repayment, and most importantly, the total repayable amount. A headline rate does not always mean a cheaper loan. This is because fees, loan terms, and interest charges can significantly change the total cost. 

APR includes the total cost of a loan. The higher the APR, the more you pay in total on the loan. The blog discusses the aspects that you must check before getting a loan in the UK. 

What is a loan interest? How does interest rates work in the UK?  

Interest is an amount that a lender charges you for borrowing money. Precisely, an interest rate is the cost of borrowing money for any purpose. It is usually represented as a percentage and is added to the amount that you borrow. 

If you want to borrow money quickly in the UK, check and compare loan interest rates first and then APR. It may impact the overall amount you pay.  Before borrowing, you must know the difference between the loan interest rate and APR. 

• APR- the total annual cost of a loan. It includes interest costs. 

• Interest- cost of borrowing a loan 

For example, if you borrow £1,000 over two years at an 18.6% representative APR, you pay a monthly repayment of £50 and a total repayable of £1,189—meaning £189 in interest. You can take reference from moneyhelper.org to understand how much borrowing £1000 may cost you 

However, the actual rate may differ from the advertised “representative” rate. A representative rate is the rate the lender expects at least 51% of successful applicants to receive. Your personal rate depends on your credit history, monthly income, outgoings, and the respective lender’s affordability assessment. 

The simplest way to estimate interest is to apply the following formula: 

Interest = Principal × Rate × Time 

• Principle: The amount you borrow 

• Rate: The annual interest rate represented as a decimal 

• Time:  The length of the loan in years 

Also, the interest rates can be fixed or variable. A variable interest rate loan means that your monthly repayments and total payable amount may increase or decrease according to economic fluctuations. 

Which factors may affect loan interest rates in the UK?  

Here are some factors that may determine the interest rate on a personal loan: 

• Credit score and credit history: A good credit score and strong credit history help you get lower interest rates on personal loans. Alternatively, missed payments, loan defaults, and CCJs may lead to high APRs. 

• Income and employment stability: reliable income reveals your ability to repay the dues on time. Alternatively, individuals with seasonal income or employment gaps may struggle to get better interest rates. 

• Loan term: A longer repayment term on a loan means you pay higher interest costs, and vice versa. 

What is an APR on a loan? Why does it matter?  

APR, or Annual Percentage Rate, is the annual cost of a loan that one pays. It is mentioned/represented as a percentage. It includes interest costs and other associated loan charges like establishment fees, administrative charges, closure fees, etc. However, APR does not include missed payment charges or penalties. 

APR is an important parameter that one must compare while checking loans. Focus on getting a loan with the lowest APR percentage. It proves the most affordable one given your finances and ability to repay the dues. 

You may spot 2 main types of APR while exploring loans: 

• Representative APR: It is the advertised APR percentage, which is usually low. Only a few customers may qualify for it. 

• Final APR: This is the actual APR that you receive on the loan. Lenders calculate it by checking your income, monthly expenses, debts, employment stability and savings. 

How does APR affect the loan repayments?  

Here is how APR affects the loan repayments: 

• Higher APR means higher monthly payments: With the same loan amount and term, a higher APR increases the interest charged, so each monthly instalment is larger. 

• Higher amount increases total amount repayable: You pay more over the life of a loan because APR includes interest and certain fees. 

• Missed payments increase APR: Yes, missed payments and loan defaults increase the APR that you must pay on the loan. It is because it increases the interest on the loan. 

• Fixed Vs. Variable APR: With a fixed loan APR, repayments remain the same unless you miss a payment. Alternatively, with a variable APR, changes in the rate can alter your monthly instalment amount and the total loan cost. 

• Use APR to compare, but check monthly payments as well: Do not check just the APR. Instead, analyse how much you must pay monthly on a loan while comparing loans. 

How does APR work?  Explain with a representative example.  

APR helps you compare loans and find the most affordable of them all. Let’s understand this with an example: you decide to borrow money with bad credit in the UK for urgent Christmas needs, like repairing the furniture. You need to bridge the cost and borrow £1000.    

• You borrow £1,000 for one year. 

• Interest charged: £60. 

• Compulsory arrangement fee: £40. 

• Total cost of borrowing: £100. 

So, the APR is 10%, and your total repayable is £1,100. Here is how to calculate APR on a loan in the UK: 

APR = 100/1000 ×100 =10% 

What do you mean by Total Repayable amount on a loan?  

The total repayable amount is the complete amount that you must pay over the life of the loan. It includes costs like principal, interest, APR, compulsory fees, and charges. However, it excludes default charges like missed payments. 

You can use the following formula to calculate the total amount repayable on a loan: 

Total repayable=Amount borrowed+ Interest+ Mandatory fees 

For example, if you borrow £5,000, pay £1,000 in interest, and pay a £100 arrangement fee, your total repayable amount is £6,100. The monthly payment may seem affordable. However, the total cost tells you what the loan really costs. 

What is the difference between total repayable amount and monthly repayments? 

Total repayment amount is the full amount you must pay over the loan course. It includes the amount borrowed, interest costs and other mandatory charges. Alternatively, a monthly instalment is a part of the loan in which you pay a fixed amount every month on the loan. 

How does loan term impact the total amount repayable on a loan?  

Borrowing a loan for a longer term increases the total repayable amount but reduces the monthly instalment amount and vice-versa. 

Longer term = lower monthly payments 

• Longer term = more interest costs. Interest has more time to build up, so the total amount repayable usually increases. 

• Shorter term = higher monthly payments. If you choose a shorter repayment term, you pay more monthly. However, the interest liabilities reduce. 

• Shorter term = less total interest. You pay less interest overall on a loan as the loan gets paid sooner. 

• The loan amount and APR still matter. The amount you borrow and the repayment term decide how much you should pay in total on the loan. 

• Shorter term= affordable loan. If you can repay a higher amount per month given your income, you can clear the loan quickly. It may prove affordable. 

For example – if you borrow £1,000 for over 18 months, you pay £102.42 as a monthly instalment, and your total repayable amount is £1,843.60. 

Bottom line  

Therefore, APR, interest rates and the total repayable amount- all 3 aspects- decide how much you pay in total and monthly on a loan. APR and interest rates may vary across lenders. 

Therefore, one must explore and pre-qualify to fetch the most affordable APR and loan interest rates. Check the total cost of a loan, not just the APR. It will help you know how much you must pay monthly and what the total loan cost includes. 

FAQs 

1. Does a lower APR always mean a cheaper loan?  

No, not always. A lower APR is better. However, you must also compare the loan amount, interest rates, monthly repayments, and total amount repayable before taking a loan. 

2. Can I repay a loan early? How does it benefit me?  

Whether you can repay a loan early depends on your lender’s terms. You can do so if the lender allows and you have enough flexibility to overpay without affecting the basic expenses. Paying the dues early helps you save money on total interest costs. 

3. Are fees included in the APR?  

Some mandatory loan fees are included in the APR.  However, the optional add-ons, late-payment charges, and some early-repayment charges may not be. Always ask the lender for a full breakdown of the loan costs or the APR. 

4. What is more important: Total repayment amount or monthly instalment?  

Both matter on a loan. The monthly payment shows whether the loan fits your budget, while the total repayment shows the full cost of a loan over the loan term. Choose a loan you can afford monthly, and it should not cost more than necessary overall. 

5. What should I check before accepting a loan offer?  

Check the APR, monthly instalment, loan term, total amount repayable, fees, early-repayment rules, and whether the interest rate is fixed or variable.