Most of us need to get a loan from private or mainstream regular banks for one reason or other. When private direct lenders and Govt. banks are approached for borrowing, getting different proposals at different interest rates and terms and conditions are common for the UK residents. If A takes a loan from a bank at a certain interest rate, B may take the same amount loan from the same bank at a different interest rate. Same is the case with private direct lending agencies.
First time borrowing may be confusing because of several questions in mind.
Why does the same financing agency offer different interest rates to borrowers for same amount loan?
How does the interest rate affect the borrowing cost?
Can you assess your credibility yourself?
What is APR? How to Calculate Annual Percentage Rate (APR)?
Q. Why does the same lending agency offer different interest rates for same amount loan?
Ans. Each agency follows its own methodology to judge the borrower’s credibility. The certified score plays a major role in defining your credibility but different lending agencies use different online calculators to scale this parameter. The professional status, regular earning and expected capability to pay the monthly instalment are the key factors that affect the offered interest rate. The required loan amount and repayment period are also the vital aspects that affect the total loan cost because of different APR.
Q. How does the interest rate affect the borrowing cost?
Ans. The offered interest rate affects the loan cost even if you take it for short-term. The short-term loans are offered at higher interest rate if compared to that of long-term instalment loans. Even if you take a small amount loan for a short-term, it may cost you more than the high amount of long-term loan. The higher interest rate may cause failure in on the time payment drawing heavy penalties besides generating red marks on your credit report. Borrowing cost is the total loan cost you pay until the complete payoff.
Q. Can you assess your credibility yourself?
Yes, there are numbers of free to use credit score calculators that facilitate to have a fair idea of credit score and credibility. The low credit score tends to increase the loan cost besides limiting the options to choose the financing agency. If you have a regular earning pattern as per your salary report, the chances of getting a low-cost loan to become high.
Q. What is Annual Percentage Rate (APR):
An annual percentage rate is an annual rate that you pay for borrowing. The term, expressed in percentage, represents to an annual cost of loan over the entire repayment period. It includes all the fees and costs. As loan agreements are made with different transaction fees, penalties, interest-rate structure etc, the APR computation provides the borrowers a figure that helps them compare the cost of the loan from different agencies. APR standardizes the offered interest rate with reference to repayment period. Loans are provided at fixed and variable APRs. The fixed APR credit has fixed interest rate for the entire repayment period, while the interest rate of variable APR credit is variable.
Q. How to Calculate Annual Percentage Rate?
Loans offered by different agencies are often confusing because of different interest rate and terms and conditions. The difference in penalties and fees also makes the decision a challenging task. The accurately calculated APR helps you compare apple with apple. There are three ways of calculating annual percentage rate:
1. Compounding interest rate for each year without accounting fees.
2. Adding fees to due balance and making the total due amount the base for computing the compound interest.
3. Accounting the total fee as a short-term loan due in initial payments. The unpaid balance is considered as the second longer-term loan.
How To Calculate The Offered APR:
For example: You are offered a loan of £ 1,000 with 4% monthly interest rate and £ 100 processing fee payable at the end of 1st month. Here are three ways of calculating APR:
1. The compounded interest rate per year without fees is (1 + 0.04)12 – 1 = (1.04)12 – 1 = 0.6010 or 60.10%;
2. Adding fee to due balance, you get £ 1,000 + £ 100 = £ 1,100. Taking fraction of £ 100 to £ 1,100, we get 1 / 11 = 0.0909. The compounded interest rate will be (1.04 + 0.0909)12 – 1 = (1.13)12 – 1 = 3.3345 or 333.45%.
3. When you add fees in the timeline created while finding time value of a granted loan, the APR will be:
PMT refers payments due for each period; i refers the annual interest rate; m refers no. of short periods / year; and n denotes the no. of years.
Disadvantages of APR:
APR doesn’t account the changing rates. For example, the Annual Percentage Rate of home loan is calculated by considering the total interest and charges over the repayment period. If you choose a variable interest rate plan, then the calculated APR wouldn’t be accurate because the interest rate keeps fluctuating. APR accounts all the potential fees/charges, even if you don’t pay some of those all through the repayment period. APR is the annual calculation, it is not a good measurement for comparing credit proposals for less than 12 months. APR may not be the perfect scale to judge the actual loan cost, still, it allows comparing the actual borrowing cost at different lending sources.
Making an excel sheet with different columns for each lending agency helps you see all metrics in one glance. Spreadsheet too can be used to calculate the cost but it needs you to have perfection in using formulas. Direct lenders often advertise Quoted APR that is simple ‘flat’ interest rate for the year; it doesn’t account the compounding of interest. Effective APR accounts the compounding if the interest rate and represents the real borrowing cost. Before sealing the deal for long-term or 12 months instalment loan, be clear in mind about the cost you will pay for the desired financial help.