APR, AER and EAR What’s do they mean - loans
Do you look at the advertisements for loans and savings and wonder what APR, AER and EAR mean? Well you’re not alone. Even bank staff can get confused!
APR is short for “annual percentage rate” and describes the true cost of the money you borrow on loans, mortgages and credit cards. The exact calculation for APR takes into account the interest rate, when the interest is charged (daily, weekly, monthly or annually), all up front fees plus any other costs. The precise mathematics behind the calculation are specified and policed by the Financial Services Authority and all financial institutions have to adhere to it. There are no exclusions! The APR therefore enables you to make direct cost comparisons between the lenders who are offering you money.
So if one lender is offering you a mortgage at 4.8% plus an arrangement fee of £600 and another is offering you an interest rate of 5.2% with a £150 fee, then the APR calculation will show you which of the two mortgages is the cheaper.
When you see the expression X% APR variable, this means that the cost is currently X% but the interest rate is not fixed and can vary.
Then there’s yet another variant - X% APR Typical variable. You’ll almost always see this expression in advertisements for loans. This means that the lender cannot be totally specific about the interest rate they will offer you as the rates they charge varies, normally in response to the amount of money you want to borrow and your personal credit rating. So the calculation for X% APR Typical variable is used to give you an idea of what interest rate you can expect. The addition of the word “Typical” means that at least 66% of their approved applications are offered that rate or cheaper.
Now lets look at EAR. EAR stands for “equivalent annual rate”. It’s used to show the cost of overdrafts and any type of account that can be in credit and also go overdrawn. The calculation shows you the true cost if you use the overdraft facility. Like the APR calculation, EAR takes into account the interest rate and when the interest is charged to the account plus any additional charges. So in most respects APR and EAR achieve the same thing – it’s just that APR’s apply to a product that is entirely a borrowing facility whereas EAR applies to a product, such as a bank current account, that can be in credit or overdrawn.
By the way, both the calculations for APR and EAR exclude any Payment Protection Insurance you’ve decided to buy to run alongside your borrowing facility. That’s because this insurance is always optional and not a cost built in to the lending.
AER is quite different. It’s only used in relation to savings and investments. It’s all about the rate of return you will receive. AER is short for “annual equivalent rate”. It shows the true rate of interest you will have received by the end of the year. It takes into account the regularity of which interest is added to the account as this has a compounding affect upon the interest you receive. The calculation also strips out the affect of any introductory bonuses that disappear after a few months – a popular trick used by institutions to boost their products to the top of the Best Buy tables. AER is a most useful tool.
It’s not easy to remember all this but we hope that the mists of misunderstanding have been removed!
