Representative APR Guide

Anyone who has applied for credit cards, loans or car finance in the past few years will have seen the term 'Representative APR', but how many of us understand its meaning, what makes it different to other APR calculations, and why is it representative?


What is an APR?

Woman on computer choosing a credit card

The term APR is an abbreviation of 'Annual Percentage Rate', which is a compound interest rate used by lenders to express the interest charged for borrowing money over one year.

Of course, not all borrowing takes place over one year. Indeed, the revolving nature of credit cards means debts can 'roll on' for a considerable time, but to help consumers directly compare the cost of different products on an equal footing, every UK lender must use the same APR calculation.

In February 2011 the Consumer Credit (EU Directive) Regulations 2010 replaced and harmonised existing UK credit legislation, and introduced the term 'Representative APR' to credit marketing.


What is a Representative APR?

Before the introduction of the Representative APR, credit marketing differed by product. Mandatory fees and charges (that were not part of the interest calculation) were used by some lenders to increase borrowing costs while maintaining a lower advertised APR.

The Representative APR sought to address this, by requiring that fees and charges were included in the overall interest calculation, to make them directly comparable across suppliers. In the case of credit cards, this means that annual fees must be included in Representative APR.

To prevent lenders using different borrowing amounts to disguise the cost of credit, the Representative APR also requires that all calculations are to be made using the same amount. For credit cards, the amount is £1,200, unless an issuer knows it to be less, in which case they must use the lower number (e.g. they do not offer a credit limit higher than £300).


How is a Representative APR representative?

The interest rates offered to accepted applicants can vary, based their credit score and income, through risk-based pricing. This can be advantageous to customers, since it enables some to access credit they otherwise would be declined for. However, without restraint, nothing would prevent lenders aggressively promoting low-interest rates, which they ultimately offer to very few customers.

The law, therefore, requires that the advertised APR is 'representative' of the credit agreements the lender intends to strike with applicants. To be representative, the APR must therefore, be the rate offered to at least 51% of applicants.

In practice, not all credit card issuers use risk-based pricing, so the advertised rate is often the rate you will receive, should your application be successful. Where this is the case, the card issuer tends to highlight this on the associated product page.


What is the Representative Example?

Although the term Representative APR replaced Typical APR in UK credit advertising, much of the methodology for the calculation remains unchanged. The most visible change to credit advertising is the requirement for a 'Representative Example' to be included in an advertisement in certain circumstances, including;

  • When an inducement is offered to customers for taking a particular product (e.g. 0% balance transfer)
  • When claims imply that terms are more favourable than other creditors

Representative Examples must include certain predefined elements to enable customers directly compare products. These elements are:

  • Representative APR
  • Whether the interest rate is fixed or variable
  • The nature and amount of any other charges or conditions (such as an annual credit card fee)
  • The length of the agreement, unless the credit is open ended (such as with a credit card)
  • The total amount of credit, or for variable products (such as a credit card) an example based on a standard borrowing of £1,200, unless the lender's maximum credit limit is lower than £1,200 - in which case they must use the lower amount.
  • The name and postal address of each advertiser or credit broker.

The legislation also defines how Representative Examples must be displayed; prescribing that they should be:

  • Clearly legible
  • Use plain language
  • All financial information must be grouped together
  • The Representative example must be at least as prominent as the trigger which necessitated its display

How useful are Representative APRs?

Although Representative APRs have made product comparison easier for consumers (by wrapping all the fees and charges associated with borrowing into one directly comparable figure), they are not the only thing you should consider.

Every customer and every situation are different, but Representative APRs use simplified data and standardised assumptions. For this reason, they offer little to no insight as to;

Downsell rates

Given that almost half (49%) of the accepted customers may get a higher APR rate, these should be checked before application.

Likelihood of acceptance

Every lender has different acceptance criteria for applicants, and the APR (regardless of high or low it is) is not necessarily indicative of who will be accepted.

Other fees & charges

Representative APR does not account for the additional charges some customers incur (e.g. late payment charges). If these are high, they can make a seemingly good product a bad choice.

Repricing

Representative APR only shows the rates that new customers are offered, which often differ from the interest existing customers are charged. Customer can, and are, regularly 're-priced' to different interest rates.

Total borrowing cost

Because APR only shows the cost of borrowing over the course of a year, it offers no insight into borrowing costs for people borrowing beyond a year (as many credit card customers do). This means people can often vastly underestimate the total interest they are paying.

For instance, if you spent £300 on a credit card, and never made another purchase, you would pay almost £600 in interest (assuming minimum repayments were 3% with a minimum payment of £5.00), if you only paid the minimum each month. On an APR basis, you would only ever have paid 34.9%, but, on a simple interest basis, the interest rate would be close to 100% - a considerably higher rate.


What affects the APR you are offered?

The APR you are offered may vary depending on a number of factors; the most important of these is your credit score.

Lenders use data from your credit file to get a full picture of your current borrowing and repayment history. If you have missed repayments, they will assume that lending to you carries greater risks. They reflect these risks by increasing the APR you are offered - A higher APR enables them to regain the money they have lent, while you are in a position to repay.

Aside from your credit score, lenders will also be considering their own position. Their customer acquisition targets, what it costs them to borrow, and the risk profile of existing customers.


http://www.legislation.gov.uk/uksi/2004/1484/made
http://www.legislation.gov.uk/ukpga/1974/39/contents
http://www.legislation.gov.uk/uksi/2010/1010/contents/made
http://www.legislation.gov.uk/uksi/2010/1970/contents/made
https://www.gov.uk/government/consultations/a-new-approach-to-financial-regulation-transferring-consumer-credit-regulation-to-the-financial-conduct-authority


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