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Published by The Times on April 8, 1995
APRs - misleading, misused or misunderstood?
Sir, You reported in ("What is the true cost of a loan?", Weekend Money April 1), that a leading independent financial adviser finds that the APR "is a completely worthless experiment now", the deputy director of a West Country Trading Standards Office says "it is wholly flawed - it stinks", a leading Building Society finds that "the figures now mean little to anybody", an even larger Society finds "the whole APR system a nonsense", whilst a consumer watchdog says the situation is "absolutely outrageous" . Weighty opinions indeed! May I suggest that APRs are not inherently misleading - sometimes misused but often badly explained.
The Annual Percentage Rate was designed in 1977 to provide consumers with a "true rate" benchmark. It represents an equivalent rate with interest payable annually in arrears. Thus mortgages with interest payable monthly, car loans with flat interest calculated on the initial amount and no allowance for the monthly reducing debt and deposits with simple interest only payable at the end of a five-year term have to quote the equivalent true annualised rate.
The old system of assuming the current variable rate for the remainder of the 25-year term was misleading. Assumptions on what happens to interest rates can be made well after the Devon cows come home. Also, few fixed rate mortgagees intend to keep to the full term.
Under the new method of assuming the fixed rate over the whole term the borrower has a good feel for the APR over the fixed term. S/he can then decide on a likely term, say seven years and make various assumptions on the average variable APR over the remaining term, say 7%, 10% and 13%. Averaging of the fixed and variable APRs over the 7-year term provides a good approximation of the composite APR.
related articles:
"Mortgage repayment penalties"
"Guaranteed annuities - no excuse for not managing risk"
"Sadly misunderstood APR deserves a much better explanation"
11 February
2003
Warren Edwardes interviewed on APRs for the BBC 2 Television
programme "working lunch".
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