If you've been looking for a loan recently, it's quite likely that you will have noticed that lenders are now advertising a Representative APR'. This was brought in during early 2011 to provide a clearer indication of the interest rate that the majority of borrowers can expect to pay on their loans. Whilst it covers all forms of borrowing, the biggest impact has been seen on the short term loan industry.
By and large, the introduction of representative APR hasn't had a huge effect on the interest rates that most companies are showing. The percentage may have fluctuated slightly, but most were using a similar way of calculating their interest, which meant that the legislative change had a minimal impact.
The major benefit for those who are seeking to borrow money is that it is a whole lot clearer just how much you're likely to have to pay. With the representative APR indicating the rate of interest that at least 66% of applicants achieve it is very much a majority figure.
This measure has been introduced to stop companies from advertising one rate to lure in customers and then offer a completely different one following the application process. You will quite often find that once you get through all the forms and various checks that the final offer has an interest rate that is far removed from the one that you believed you were applying for. With representative APR, this should happen less; with only a third of applicants susceptible to alterations.
But whilst long-term loans have been largely unaffected by the introduction of representative APR, the short-term loan industry hasn't been quite so fortunate. The reason for this can be attributed to one thing: the calculation of APR.
With a short-term loan, often referred to as a payday loan, the interest rate is based on a basic monthly or daily rate. Whilst this might not eclipse 25% over the course of 30 days, when it is stretched out to 365, the numbers can become massively skewed.
As an example, if you were to borrow 200 from a short term loan company that charged 25%, you would have to pay back 250 on your next payday. Pretty simple so far. However, representative APR isn't based on monthly borrowing, it's an annual rate of interest. Therefore, you would have to apply the same amount of interest each month, with the cost increasing rapidly as indicated below:
Month 1: 250 (Interest 50)
2: 312.50 (Interest 62.50)
3: 390.63 (Interest 78.13)
4: 488.28 (Interest 97.65)
5: 610.35 (Interest 122.07)
6: 762.94 (Interest 152.59)
7: 953.67 (Interest 190.73)
8: 1,192.09 (Interest 238.42)
9: 1,490.12 (Interest 298.02)
10: 1,862.65 (Interest 372.53)
11: 2,328.31 (Interest 465.66)
12: 2,910.38 (Interest 582.08)
As such, using this very basic model, the total amount of interest paid over the course of a year for your original 200 loan would be 2,710. This gives you a representative APR of around 1355%. However, the total rate would have to include any additional charges and fees. So if there are any late fees or transfer costs then these would need to be factored in.
So you shouldn't be too surprised to see a payday loan company advertising representative APR of over 1500%, certainly those who charge a flat monthly rate. Where a daily charge is applied, usually around 1%, this can sky rocket up to 3 or even 4 times this amount, again purely because it is a method of calculating long term borrowing, which is then applied to short-term loans.