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What is the Difference Between Flat Rate and APR? Explain the Difference Between APR and Flat Rate

Difference between Flat Rate and APR

Whenever we wish take on any kind of credit arrangement - whether it be a mortgage, a hire purchase agreement, a credit card, car finance or just a straight cash advance – one thing that will attract us towards a specific provider is likely to be the interest rate.

Lenders generally do not offer out loans for no gain, and the amount of interest you pay is usually the single most important factor to consider when sourcing finance of any kind. A few percentage points can make a great deal of difference over a period of time, and in some cases can even be the deciding factor in whether or not repaying the loan is actually viable.

It is natural then that we should be attracted to an offer which quotes a low percentage when it comes to interest payments. However it is extremely important that a borrower understands the difference between flat rate and APR, and is aware of which of the two he or she is being quoted. Failure to differentiate could result in one having to repay substantially more than may otherwise have been necessary.

Essentially an APR (Annual Percentage Rate) is a simple calculation of the repayments based upon a combination of four factors - the actual interest rate itself, when it is charged (i.e. weekly, monthly or yearly), set-up fees and any other miscellaneous costs. All four of these factors are combined to calculate the APR, which as the name suggests is an annual interest figure.

A flat rate loan, on the other hand, quotes a permanent rate of interest based upon the total sum of the loan.

Herein lies the essential difference between flat rate and APR – the percentage interest on a flat rate quotation will be constant for the duration of the loan, based upon the total amount borrowed. Thus if the sum of £10,000 is borrowed at a flat rate of 7% over a period of five years, then each year the borrower will be required to pay £2,000 in repayment of the loan, plus £700 in interest. When the first four years have passed the borrower will only owe £2,000 on the loan, yet will still be required to pay £700, the flat rate of interest, which by this time will of course amount to 35% of the remaining balance.

By contrast an APR requires one only to pay interest on the outstanding balance. So if the same borrower was to take out a finance package at an APR of 10% then in the first year £1,000 would be repayable on the same £10,000 loan, but after four years of repayments and with £2,000 left to pay, only £200 would be repayable in interest and even this amount would decline as additional payments are made.

It is important therefore when taking out a loan or looking for credit to recognise the difference between flat rate and APR, because a lower flat rate does not necessarily mean you will pay less and in practice usually doesn’t.

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