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13 December 2016

**Don't know your APR from your EAR?**

Well maybe it's time for a human-friendly explanation of all the lending acronyms which, I reckoned, would only take a few minutes to write. It has taken 3 days to make sure it's correct, I hope...

There are all sorts of mad ways of calculating the cost of debt. It seems that every method depends on hiring a private detective, or getting a maths degree, to work it out. I was so astonished that I had to call in my crusty Finance Director, Nigel, to check the smallprint. Even Nigel, who crunches merrily through numbers like a ferret in a box of cornflakes, is still scratching his head wondering if we finally got it all right.

Confused? You will be.

Let's start from the top. The not-so human-friendly UK technocrats have gone bonkers with a collection of abbreviations that, well, spookily all look much the same: AER, EAR, APR, and Effective, Typical or Representative APR. If that's not bad enough the formula for actually working out an APR looks like something from a nutty Maths professor.

**So what is an APR actually?**

An APR is the Annual Percentage Rate; or in other words what it actually costs over 12 months to borrow money. So, if you borrow £100 at 10% interest rate it will cost you £10 per year. Easy right?

Ah. Well not quite. That would be too easy to understand. This part is just the "nominal" interest rate.

Then you have to add in something called Compound Interest. When you borrow £100 at 1% per month for a year, it immediately starts to attract interest charges, so they can charge you more interest on this interest (and mathematically more interest on that more interest-on-the-interest and so on, like Buzz Lightyear, "to infinity and beyond"!).

Anyhow, an APR adds on more interest on interest. Then the lender will usually chuck in some other fees and charges. And that's your lot. This is what makes it the "Effective APR"! (well, very effective for them anyhow.....).

The result is that a rate of 1% per month, giving a nominal interest rate of 12%, might actually end up being an effective APR of 15% or more. £100 at nominal interest of 10% might look like costing £10 a year whereas the effective APR is 15%, so it costs you £15 a year, which is an increase of 50%!

Overall though the Effective APR is a useful measure to let you know how one complete cost compares to another.

So....what's an AER?

Pass. We won't deal with AER here, but it's pretty much the APR for savers.

**Hang on, it says this is a "Representative" APR?**

So in theory we have got to a 15% effective APR. OK, great. Can I have that deal please? Ah well no, sorry. Your APR would be 30%.

WHAAT? Yeah, sorry, that's why we said it is a "Representative" APR? Or, just to keep you on your toes, it might also be called it a "Typical" APR.

You see, there's a near even chance that YOU may not be quite "typical" enough. That's because anyone getting an unsecured loan is only marginally (51/49) odds-on to get a loan at the rate advertised. What it means that they have to ensure that at least (!) 51% of loans go out at the advertised rate.

So what about the other 49%, "un-typical" loans?? Ah well, those other 49% untypical oddballs like you will get another, higher rate! You would have thought the ads should say "lowest potential rate 15% APR", but I guess that would be too easy.

So when you read "Representative" or "Typical" APR remember that it's a bit like saying: "As a lender we promise that typically we will only actually give these rates 51% of the time!!". Not the best start to a relationship, eh?

**EAR, ear, what's the APR on an unplanned overdraft?**

Ah, the bankers have their special exclusion zone in overdrafts.

Just to make things nice and simple, bankers don't have to declare an APR to overdrafts and unplanned overdrafts, and indeed they have several completely different ways of measuring them. If they charge interest, they call it an EAR (Equivalent Annual Rate).

More like, Oh dEAR.

It all starts rather well. As with unsecured loans, bankers work out the cost of overdrafts as interest and (compound) interest on the interest. OK. Good so far. Looks fair enough too, at about 19.5%.

But then, sneakily, somehow they have managed to persuade the authorities that, unlike loans, whenever they show the cost of overdrafts they DON'T INCLUDE FEES and CHARGES! So, naturally enough, the clever clogs bankers can set an OK looking EAR, and then BOOM!!! In come a load of heavy charges which they list separately. These charges can be up to £50 a month PLUS 19.5% interest.

OK then, listen up and get your EAR clear

The closest thing to overdrafts, is the short-term or payday loan. But payday lenders have to advertise a representative APR even for the shortest of loans, far shorter than most overdrafts. So they can look comparatively expensive, when in fact they can well be much cheaper than bank overdrafts.

Meantime the bankers either get away with hiding behind the EAR (which may not include additional fees and charges) or they can simply list daily fees that seem cheap but, as you will see below, are not.

**Here is one very extreme example:**

A loan of £100 for 20 days from a leading payday lender (no prozes for guessing) would cost you £10.40, according to their website calculator.

By my own calculator, ('cos the bank doesn't offer one. Hmm), the same £100, 20-day loan as an unplanned overdraft from a major bank brand would cost you £100. That's a little bit, er, "extra".

So to be clear:

- to borrow unplanned £100 from a leading bank brand for 20 days will cost £100
- to borrow £100 from a leading payday brand for 20 days will cost £10.40.

Quite a difference eh?

But it gets worse: the payday lender has to show their charge as a seemingly staggering 1,509% APR whilst the bank, which is 9x more expensive, can look nice and cheap at £5 per day.

However, and you should cover your eyes here if you are of a sensitive nature, the corresponding APR for the bank unplanned overdraft on this example is.... over 30,000,000% APR. Yes, that is 30 million % APR. (I know, I know, the wonders of maths, but I am assured by qulaified mathematicians that this IS correct).

By the way, the same loan, on a planned overdraft basis from the same major bank would still cost just less than double even than the leading payday lender brand, at £20 for the 20 days, at 2,687% APR assuming no other charges! (Uncle Nige's laptop melted at this point).

Not all examples will be this extreme, but it is used here to show you how much of a muddle this whole area is, and how, by and large, charges and costs are not clear, and how the game is tilted in the banks' favour, not yours.

**Level playing field please**

Our conclusion was that, when you simply want to know what a loan will cost for a period time, why can't that be what they have to show you?

Eg. "Borrowing £100 for 100 days will cost you £10".

For comparison purposes, to check you have the best deal against all other forms of borrowing, they should also have to say:

Eg. "£100 borrowed on this basis for a year will cost £150".

It just seems that in the overdraft area especially, it is all an un-standardised mess which makes it really hard to work out how much you actually pay or what fair comparisons are. But, of course, whose interest might that be in, we wondered?

The good news however is that now you no longer need a bank at all. These days you can get a huge choice of loans, often much more cheaply, from other non-bank providers; you can also manage your day to day personal money without needing to involve bankers.

If the regualtory authorities won't level the playing field, it is probable that honest and transparent competition might.

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