Don’t know your AER's from your APR's? We explain it all in our everyday banking jargon buster:
AER - (or Annual Equivalent Rate) refers to the yearly interest rate on savings accounts and is one way to compare different savings products when you’re trying to decide where to save or invest your money.
You'll find AER across savings products like cash ISAs, fixed rate cash ISAs, easy access savings accounts and fixed rate bond accounts. The AER factors in compound interest and should help you calculate the amount you could earn over the course of a year if you deposited money in the account and left it there. You’ll also notice banks and financial institutions talk about the gross rate of interest and that refers to the interest you'll earn before any deductions like income tax, though you won't have anything taken off below your Personal Savings Allowance. Just make sure that you compare like-for-like rates when researching products to avoid confusion.
APR - As part of The Consumer Credit Act all creditors have to be transparent and always present the full cost of credit in the form of the Annual Percentage Rate (APR). This is a wider measure of the cost of borrowing, as APR includes the interest rate as well as the other charges that you may have to pay in order to get the loan, such as broker fees if you are taking out a mortgage. Because APR includes all mandatory administration fees and additional costs associated with the transaction, it’s usually higher than the interest rate.
Because of this, APR can be a useful guide to help you decide which loan or credit card is right for you and show you the 'big picture' when you’re comparing different products. Credit agreements vary in terms of interest rate structure, transaction fees and late payment charges, so for example, a loan at 12% interest could have an APR of 14%, meaning the APR give you a better idea of what you'd owe over the course of a year.
It’s helpful to bear in mind that only compulsory costs have to be listed, so always check whether the lender is including payment protection insurance (PPI) in their quote and whether you'd like to opt in. PPI is voluntary, so a lower rate APR loan with it included could end up costing you more than a higher rate without.
APR is usually advertised at a 'representative rate', which means you aren't guaranteed to get the rate on offer – though a minimum of 51% must do so. Remember, your personal rate will depend on your credit score, so if you've had issues with borrowing in the past, you might be offered a higher rate than advertised.
Finally, APR is always worked out as if you were borrowing for a year. If you can pay back what you owe earlier and choose to do that, you could be charged early settlement fees.
Consumer Credit Act The Consumer Credit Act 1974 (amended in 2006) is a piece of government legislation that regulates consumer credit and consumer hire agreements in the UK. In other words, it controls how banks and financial institutions can lend to you and covers everything from personal loans and hire-purchase agreements or credit cards and store cards.
Even if you've never heard of the Consumer Credit Act before, there's a good chance you've already benefited from the protection and rights it offers you, like:
- Your right to look at any credit file
- The 'cooling off' period of five days when you can cancel a credit agreement
- Your right to pay off credit early
- Your limited liability or no liability when a credit card is lost or stolen
- Making sure financial institutions give you all the information you need before you decide to enter into a credit agreement
Section 75 of the Consumer Credit Act 1974 is especially important because it gives you extra protection for credit purchases that cost between £100 and £30,000, meaning you have the right to get your money back for goods or services that turn out to be faulty. If the purchases breach the Consumer Rights Act 2015, you can get money back from the creditor instead of from the trader, which can be useful if the trader is uncooperative or goes out of business.
It also applies to things you buy abroad or to goods purchased overseas on the telephone, internet or mail order for delivery to the UK. This is an extra level of security you don't get when making purchases on debit cards, charge cards, bank loans or store cards.
Interest – When you borrow any amount of money from a bank or financial institution, you agree to pay it all back again, known as ‘paying off the principal’ in financial terms. Lending money comes with a certain level of risk, so to compensate the lender for this risk, you’ll be charged an additional fee alongside the principal, and that's what is known as the interest. Different lenders charge different amounts of interest depending on the type of agreement. It's not always a one-way street though – if you put money into a bank or building society in a product such as an ISA that you agree not to touch for a certain period of time, they can pay you interest on this money.
Interest - How does it work - There are two different types of interest: simple and compound. Understanding the difference between the two can help you better understand borrowing.
- Simple interest - here, the borrower pays the lender a fixed amount over a set period of time. Simple interest is calculated only on the principal amount of a loan using this formula:
Simple interest = principal x interest rate x term of the loan
To give an example, let's say you want to borrow £1,000 over a period of 12 months, for which the bank charges you 5% simple interest. After one year, you would owe the bank £1,050. Most banks move simple interest in line with the Bank of England Base Rate. When the Base Rate changes, you'll see your simple rate change by exactly the same amount.
- Compound interest - this can be more complicated, because your rate factors in the interest paid on interest, as well as your remaining balance. That means for each period, you'll need to take into account your current balance, interest accumulated up to this point, then interest accumulated on each for the current period.
This time, let's say you have a balance of £1,000 on a credit card on a simple interest rate of 12% (giving a monthly simple interest rate of 1%). To make things clearer in this example, we'll say you won't pay anything back for a full year, though in reality you'd have to pay back at least the minimum each month. After a month, you'd owe 1% of £1,000, which is £10, making your outstanding balance £1,010. The next month, the 1% would be charged on that £1,010, adding £10.10 to your balance to make it £1,020.10. This incremental increase continues each month, meaning that by the end of the year, you'd owe £1,126.83.
Please note: This is a figurative example and does not directly correspond to any NatWest product or service.
If you miss payments or pay late, you could be charged fees and your credit rating could be affected, so it’s important to pay at least the minimum amount each month, although paying your balance off faster can decrease the overall amount owed.