UK Credit Guide: Interest

Unless you borrow from a friend or get a special 0% rate, lending money will always accumulate some form of interest. In a nutshell, interest is the profit made by the lender for loaning out their money. Some have a fixed rate, others are variable, some are added monthly, others yearly, but what does it all mean?

How is it calculated?

Generally, the rate of interest offered is based on the level of risk, so those with a poorer credit history might not be able to access the same rates as those with a good credit history. Interest is calculated as a percentage of the amount borrowed and displayed as an APR.

What does APR mean?

Annual Percentage Rate (APR) is the percentage of interest added to the amount borrowed over 12 months, this may also include any fees or charges added by the lender. All lenders must advertise their APR clearly to customers.

Representative APR

All regulated lenders must display a representative APR. This is an example of how much it would cost a borrower to lend from them. This example will include the monthly payment, total interest and total repayable, plus any fees added to the loan. This APR must be available to 51% of successful applicants but the other 49% could get a different, possibly higher rate.

Fixed vs Variable interest rates

Fixed interest rate

A fixed interest rate is a rate that is agreed upon at the point the credit is taken out and will not change through the term of the agreement. This means that repayments won’t change each month, making it easier for the borrower to manage their finances.

Variable interest rate

A variable interest rate is a rate that can either go up or down over the term of the loan. It is based on market interest rates and is calculated by the current balance of the loan. This is thought to be riskier than a fixed rate as there is an equal chance that repayments could increase or decrease through the term of the loan.

What can affect the interest:

Moving the payment date

When signing a credit agreement for a loan, you are agreeing to repay it over a set time period. Usually, the payments will be made each month on the same day the loan is approved, so if your loan is paid out on the 1st, the repayments will be on the 1st of each month after that. If you chose to move the payment date back, for example, to fit better with your payday, you’re effectively extending the loan term. This means you’ll likely accrue extra interest for those days, meaning you’ll owe a bit more money to the lender. Similarly, if you move your payment date forward you’re shortening the length of the loan, so you may end up saving yourself a small amount on interest.

Settling the loan early

By choosing to settle a loan early, you won’t be required to pay the interest for the remainder of the loan term, so, therefore, paying back less than originally agreed. However, under the Consumer Credit Regulations 2004, some lenders will charge a fee for this equivalent to two months’ interest, depending on how long is left on the loan term. You can contact your lender at any time and request an early settlement figure which will be the current balance of the loan, plus the early settlement fee if added. This figure is valid for 28 days. Just because you request a settlement figure, does not mean you’re obliged to settle early, you can continue to make your repayments as scheduled.

Late or missed payments

As the loan agreement is based on fixed monthly payments, making a late payment or missing them entirely will usually mean extra interest is accrued. Different lenders calculate and charge this in various ways but generally, this will continue to accrue until the arrears are paid and regular payments are back on track. Some lenders may also charge a late or missed payment fee, but this should be clearly stated in your credit agreement.

Please note, none of these articles are intended to constitute financial advice and should be used for informational purposes only.