Interest rate and APR - they are two terms you see a lot when you're looking to borrow money. Whether it's for a credit card or a loan, they're not always easy to understand.

What is Interest?

When you borrow money or take out a loan, you pay interest for using the money. When you put money in a savings account, you are paid interest for keeping it there. The interest rate is a percentage - it represents how much the lender wants to charge you for lending you money.

Interest is usually calculated annually by the lender. They decide this from how much money is borrowed (the principal) and how long it's borrowed for (the term). Lenders have to advertise what the interest rate is before you take out a loan.

If you take out 5,000 from a bank at an interest rate of 5%, the interest you would pay is 250.

Simple vs compound interest

Simple interest is based on the amount of money you borrow. This means the amount of interest you earn will remain the same over time. Compound interest is on top of the interest already earned.

For example, money in a savings account will earn interest for a year. As long as no money is withdrawn from the account, the interest earned over time will rise. This is compound interest and happens because the interest is still in the account.

What is APR?

When you take out a credit card, loan or mortgage, you are quoted the Annual Percentage Rate (APR). This is the interest rate plus any fees from the lender. It's designed to show the cost of borrowing.

Lenders calculate APR based on rules and regulations set by The Consumer Credit Act of 1974. This means all lenders have use the same calculation. This makes it much easier for you to compare rates from different providers.

All lenders have to say what the APR is on a loan when an interest rate is included. It will appear on your customer loan agreement too.

When the term APR is used with credit cards, it normally refers to unpaid balances. If it isn't paid, you will get charged a percentage of what you've used and any fees.

Representative vs personal APR

You will see the phrase 'representative APR' when you compare loans or credit cards. This is the rate that most customers will pay. It must be given to 51% of borrowers to be 'representative'.

If you decide to apply for a loan or credit card, you might get a different APR. This is called personal APR and is based on your financial details. These include your credit score, annual income and any other expenses. It means you could be offered a rate that is higher than the representative APR.