If you’re looking for a flexible short-term loan, the way the interest rates are described can be off-putting. If you don’t know what ‘APR’ is and you see short-term loans quoted from anywhere between 800% and 4,800% ‘representative APR’ can seem really excessive.
When a short-term lender puts an APR on the adverts, they have to do that – every short-term loan lender is governed by the Financial Conduct Authority (FCA) and that’s one of their rules for doing business.
So, why do some short-term loan APRs look so high, what does APR means, and what does it mean for you?
What is APR?
The Annual Percentage Rate (APR) is the percentage interest that you’d pay on a loan if you were to borrow the money for one year.
If you’re struggling to understand APR, think about it in terms of how many pennies it would cost you to borrow each pound, per year.
For example, if APR was at 30%, you’d pay 30p per year on each pound borrowed. Similarly, if APR was at 500%, you’d pay 500p (£5) on each pound borrowed that year. And at 5000% APR, you’d be paying £50 annually for every pound you borrowed.
The reason APR seems so high is because it’s based on if you had to do something called “refinance” your loan every single month, for 12 months.
This means that each month, the amount you’d have to pay would increase, and in turn so would the interest. That’s why APR isn’t simply your monthly interest multiplied by twelve – it’s something called a “compound” figure.
However, that doesn’t really help with short-term loans lasting less than a year – let’s look at why.
Choosing a short-term loan based on APR
APRs confuse a lot of people and make short-term loans look incredibly expensive. But, if you look at it in monthly terms, it produces some surprising results.
For example, at the time of writing, a simple search online showed that three different lenders all advertised very different APR representative rates.
Let’s call them short-term loan provider A, short-term loan provider B, and short-term loan provider C. Say you wanted to borrow £100 for six months.
Short-term loan provider A was willing to offer a 6-month short-term loan at representative 483% APR. Though this may sound high, the total repayment was estimated at £130.09. You pay 30.09% on the money you borrow which can also be expressed as 483% APR representative, a nominal interest rate of 96.89%, and an effective annual rate of 153.9%
Short-term loan provider B offered a 3-month short-term loan at representative 563% APR, with a total repayment of £131.50. You pay 31.5% on the money you borrow – but when you talk about the same loan as having a 483% APR representative, a nominal interest rate of 180.53%, and an effective annual rate of 437.5%, it sounds a lot worse.
Short-term loan provider C offered a 12-month short-term loan at 277.5% representative APR with the total repayment estimated at £190.74. On this loan, you pay 90.74% interest on the money you borrowed over the course of the loan. That sounds like a lot better deal than 277.5% representative, 140% nominal interest rate, and 275.91% effective annual rate.
APR can be a useful measure but many people inside and outside of the short-term loan industry worry that APR shouldn’t be used for short-term loans.
What’s most important to us here at Moneypod and at our lenders is that you can comfortably afford the repayment every month on your short-term loan. When our lenders make a decision, they do so with that in mind.
How does APR differ from a long-term loan?
On a longer-term loan, APR will be lower. This is because the interest has a chance to accrue due to the extended time-frame and therefore the lender can afford to decrease the rate a little.
On a short-term loan, APR tends to be much higher, as not only will interest have little chance to build up, but the loan may be paid off in as few as two or three instalments.
However, as explained above, the shorter timeframe and larger payments compensate for the shorter lending period.
What does the law say about short-term loans and APR?
In 2015, the Financial Conduct Authority (FCA) implemented a series of new regulations in order to ‘stamp out unscrupulous practices’, according to Richard Lloyd, executive director of Which?.
These rules ensure short-term loan borrowers are properly protected. They are as follows:
- Daily interest is capped at a maximum of 0.8%
- Missed payment fees cannot exceed £15, and
- Total combine interest and fees will never exceed the principle of the loan
For example, if you took out a 30-day loan, you’d never have to pay more than £24 in interest on that money.
Loans through Moneypod
Using Moneypod as your broker means we’ll match you up with a lender who can offer you the best flexible short-term loan deal for your needs. We understand that everyone’s history is different, and that’s why we and our lenders look at you, your life, and your circumstances as they are today, and not any problems you might have had three years ago.
Short term loans plug an important gap in the market – smaller amounts of money delivered quickly to people with an unexpected bill or expense that can be paid back in as little as three months.
Moneypod works with a panel of FCA-approved lenders – our job is to match you up with the short term loan companies who want to work with you. Please click for our short-term loan application.