It is often seen advertised alongside credit cards and loans, but what does 'typical APR' really mean? We bust through the jargon to find out what you can expect when you come across this familiar phrase.
What is APR?
An APR advertised on any kind of credit, whether it’s a credit card, loan, or overdraft, represents the cost of borrowing. It stands for Annual Percentage Rate and illustrates how much your credit card, loan, or other form of credit will cost per year.
For example, if you had a loan with an APR of 7.7%, this would mean that for each year that the loan was outstanding, 7.7% of the amount borrowed would be added to the total amount you would have to repay.
It’s worth noting that the APR figure will take into account all fees and charges over the year, so it is a good guideline for exactly how much your loan, credit card, or other form of borrowing will cost.
What if the APR is typical?
While an APR advertised on any line of credit would give you a good idea of how much the borrowing would cost, the issue occurs because most lenders do not simply advertise an APR, but rather a ‘typical’ APR.
The use of the word ‘typical’ means that the APR you will be offered if you applied for the credit card or loan may not in fact be the same as the rate advertised.
This is because many lenders operate on what is known as risk-based pricing, meaning that the APR you will in reality be offered on your borrowing is dependent on a number of factors; the foremost being how high-risk a borrower you are perceived to be.
If your lender perceives you to be a high-risk borrower it’s likely that you will be offered a higher APR (or even refused credit altogether). As a borrower your degree of risk is determined by your credit history and past credit behaviour.
When you apply for any kind of credit you will be given a credit check, which means your lender will review your credit history and decide how high-risk a borrower you are, i.e. how likely you are to be able to pay back your borrowing promptly.
The APR you are eventually offered also depends on how much you wish to borrow, and for how long. For example a ‘typical’ APR quoted in a loan advertisement may only apply to those who wish to borrow over a certain threshold for a certain number of months.
So how can the APR be ‘typical’?
With the APR you’ll actually be offered so dependent on a variety of factors, how can a lender advertise a typical rate at all? If an APR is advertised as ‘typical’ it means that the lender must, by law, offer this rate to a minimum of 2 out of every 3 borrowers who apply for the credit. This means that 66% of all applicants must receive this rate for it to be classed as typical.
However though at least two-thirds of applicants should receive this rate, the APR each person is offered is still tailored to the individual, depending on their credit rating and how much they wish to borrow for how long. As such it may be a good idea to take an advertised ‘typical APR’ with a pinch of salt – because what you’re ultimately offered may in fact be significantly higher.
What can I do about it?
In most cases you won’t know the exact APR you’ll be offered on a loan or credit card until you apply. As applying for several lines of credit in a short period of time can damage your credit rating (because it makes you appear as if you are in dire need of credit and therefore a higher-risk borrower), it’s not advisable to apply for various credit cards and loans just to see what kind of rate you’ll be given.
Instead it’s worth always reading the small print behind the headline rate of any kind of credit. There will very often be a stipulation that, even without factoring in your desirability as a borrower, the lender will offer a different rate depending on the amount you borrow and the term you wish to borrow for.
Some offered APRs are even dependent on the way in which you apply; for example you might be offered a different APR if you apply for a loan over the phone rather than asking about it in-branch.
In this way you should use an advertised ‘typical APR’ to give you an idea of what sort of rate you might get on application, but always look behind the headline rate to find out more about how much your borrowing is actually going to cost you.
