What is APR and how does it work?

APR interest rates explained

APRs, or annual percentage rates, can appear confusing at first, whether they're representative, fixed or variable. To help you, we've put together a quick guide to understanding the basics.

What does Annual Percentage Rate (APR) mean?

The APR is an interest rate for borrowing or saving money. It should be clearly shown on all advertising prior to you taking out credit. It includes the basic interest rate plus any additional fees of a loan or credit card agreement.

It therefore shows how much your borrowing will cost over the period of a year, which is useful for planning your finances.

Before an agreement is reached for a loan or credit card, the lender must make the APR known to the borrower. The APR can be either fixed or variable (explained below), and the rate offered depends on the lender, the borrowing amount, the duration of the loan, and your credit score.

Representative APR
This is the rate that at least 51% of applicants will be offered. It must also include the cost of any other products that come with the loan or credit card, such as compulsory insurance costs and annual fees. This protects you from changes that could happen to the APR due to other factors.

As this rate needs to be offered to only 51% of applicants, the actual rate that you're given could be higher than advertised.

Credit card advertising will sometimes show a full representative APR example, which includes a purchase APR and an assumed credit limit. The purchase APR is the rate of interest that will be charged for purchases only.

The full representative APR can differ from the representative APR which includes additional fees such as a credit card annual fee. The assumed credit limit does not necessarily reflect the credit limit that you'll receive on the credit card – this is often based on your application details and credit score.

Fixed rate vs variable rate

Fixed APR
A fixed APR is when the interest rate stays the same, rather than fluctuating according to the base or bank rate of the Bank of England. However, it can rise if payments are late.

The advantage of a fixed APR is that you know how much you'll be paying without any surprise increases, but you may miss out if the base rate drops.

Variable APR
A variable APR is when the interest rate can change, either when the base rate changes or the lender changes their own rate.

If the base rate drops then the interest on your repayments can drop. However, if it rises your payments can also increase, giving less certainty about your monthly repayments.

Types of APR

  • Penalty APR – The rate you could be charged if you trigger any penalty clauses in your credit agreement. Penalty clauses can include late payments or exceeding your credit limit.

  • Introductory APR – The interest rate lenders use as a promotion or incentive for borrowers to apply. Normally low or no interest, this rate can rise when the introductory period ends.

  • Purchase APR – The interest rate of purchases made on your credit card. Some lenders may have a 0% APR on credit card purchases for a certain period, but this normally returns to the standard APR when the promotion period is over.

  • Cash advance APR – The interest rate that some lenders and banks may apply to money you withdraw from the account, or that you spend using a written and cashed check. The cash advance APR can often be higher than the standard APR.

  • Balance transfer APR – Like a purchase APR, this is the interest rate of balance transfers made on your credit card. Some lenders may have a 0% APR on credit card transfers for a certain period, but this normally returns to the standard APR when the promotion period is over. There are a number of pros and cons to balance transfer cards.

Understanding APRs and the approximate interest rate you'll be charged can help when choosing a credit card, loan, or mortgage. You can check our loan calculator to see what loans rates we offer.

AA Financial Services previously offered personal loans and savings accounts. AA Financial Services Limited is a credit broker and not a lender.

Author: The AA. Published 18 August 2020. Updated 9 November 2023.