I'm always paying, never make it, but you can't look back

[venta]

So, sums. I can, broadly speaking, do sums. I have a degree in maths.

However, interest rate calculations have always baffled me. Sure, if you ask me to calculate 3 months compound interest at a monthly rate of x% I know what to do. However, when it comes to real examples of mortgages and credit cards, I can't work out what the sum I need to do is. I'm still slightly baffled about the interest charged me when I was a day late paying my credit card off in full in March.

Today, the BBC carried a story about a loanshark. It includes the following statement about someone who borrowed £1000:

"...to pay £49 a week over 60 weeks, making the total amount he had to
repay £2,940 at 917% APR."

Now, if we approximate 60 weeks to a year, then surely that's an annual interest rate of no more than 294%. The quoted APR isn't even in vaguely the right ballpark.

So... have I completely failed to understand APR ? (Wikipedia's page on the subject didn't really help with the definition.) Or is the BBC publishing unmitigated wank in the name of investigative journalism ?

Edit It turns out I'd failed to understand APR, and the BBC is cleared in this instance.

Comments

[onebyone.livejournal.com]

You say it's bunkum, but there's quite a close correlation between the APR of a loan, and the amount it actually costs you to borrow the money. Payday loans, for example, work out as a high APR precisely because they're much more expensive than doing the same thing using an authorised overdraft with lower APR. Payday loan companies argue that they lend to people who are too high-risk for a bank to offer authorised overdrafts to, but of course they loan to anyone who comes in the door. It's the customer's responsibility to find the cheapest loan available to them, and everyone publishing APR helps them do that.

So when you say the comparison is OK for comparable loans, I think that more loans are comparable than you might think, or than lenders admit. They're even somewhat comparable if one of the types of loan isn't available to you, since at least you know what you could have won, and can consider what it would be worth to you to somehow gain access to that lender.

Fewer people would take long-term "single low payment" consolidation loans if they compared the APR with that of their current loans, which charge more per month total, but at a lower interest rate because the repayment term is shorter.

Mortgages are cheaper than personal loans, and for good reasons - they're secured rather than unsecured debt, and they're allowed to invoke penalties for early payment. It's cheaper to borrow on a mortgage than a personal loan, because you're not buying the flexibility to pay early, or default on the debt. APR comparison fails to put a value on those freedoms, because it can't. But it does at least leave you with less maths to do than if two lenders are quoting non-standard "annual rates" which look similar, but have different compounding periods and hence are very different.

Loan sharks offer the worst of all worlds, of course - the loan is secured on your kneecaps, and it's also extremely expensive.

[mister-jack.livejournal.com]

I don't agree. The total cost of the loan is very different when comparing loans of the same APR but different terms - i.e. a mortgage and a personal loan. The length of time over which it is paid back is often the most significant factor in total cost, even over relatively short periods.

If we compare a mortgage paid back over 25 years to a car loan paid back over 3 but with double the APR; you'll actually pay more interest on the amount borrowed under the mortgage over those 3 years.

I'm not saying that APR is meaningless by any means; but it's not necessarily the most indicative of rates, especially for short term loans.

[onebyone.livejournal.com]

Sure, if it turns out that on average you're more than twice as far in debt over the period. Debt costs more if you borrow more, and more if you borrow it for longer. After 3 years of a 25-year mortgage, you're almost as much in debt as when you started, and you're still paying for that debt. APR tells you how much your debt costs per pound per year, rolling in any one-off charges. That seems straightforward and fair to me.

If you use an offset mortgage and voluntarily pay the money back in 36 equal instalments, then you'd pay less than the car loan iff the APR is less than the car loan APR. Conversely if you take out multiple 3 year loans over the course of 25 years to take your car debt down gradually, then it costs more than the mortgage iff their combined APR is higher.

I think lenders do also have to offer breakdowns of the total amount paid, which should help people decide how long a term they want to repay over, if offered multiple loans with different repayment periods. But fundamentally, as long as you have something worthwhile you can do with money, it's better to have a loan over 25 years than one over 3 years, which is why it costs more in total. If you don't have something worthwhile you can do with money, you should aim to be debt-free. APR gives a good idea what "worthwhile" means - does the cost each year justify continuing the debt another year?