APR v AER

Grasper_2

Usually loans are going to cost more in interest than you would earn in interest, so in general it is worth paying off any loans with savings. However this is not always the case. If you wished to retain some liquidity it may be worth keeping the loan, particularly if the interest earned offsets the interest paid to some extent.

The trouble is finding out exactly what the difference is, as interest on savings accounts are quoted as AER, and lones as APR. So my question is, if I have a loan of, say £1,000 at an APR of x%, and £1,000 in a savings account paying interest at x% AER, would I be breaking even, or if not, how could I calculate what the difference between the cost and earnings would be?

Calculating interest from AER should be relatively straight forward, as I understand it to be the percentage of interest payable on the amount invested, assuming that interest is paid once a year. However APR is more complex, and I've never managed to get an explanation more that "ooh its terribly complicated and you would never be able to work out the figures for your self". This I've always found very unsatisfactory, as I have no way of knowing if I've been over or undercharged for a loan. So my second question is, is calculating costs really so complicated? If not, how is it done, and if it is, how do I know I'm not being overcharged?

All answers gratefully received!

tomstickland

The savings bit is very simple, as you suggest. AER expresses how much you will be paid over a year for a fixed starting amount. So, start with £1000 and on a 5% account you will ened up with £50 extra, ie: £1050.

MarkyMarkD

Eh?

They are the same thing with different names.

If you borrow £1,000 and pay it all back at the end of the year, and the repayment is £1,050, then the APR is 5%.

If you save £1,000 and get it all back at the end of the year, and the amount you get is £1,050, then the AER is 5%.

You just compare the two rates and that determines whether, all other things being equal*, you should repay the loan or keep the money in savings.

*And as you say, correctly, there can be liquidity or other reasons for keeping the money and the debt outstanding even where the borrowing rate is slightly higher than the saving rate.

---lee---

APR can also include other things like arrangement fees.
So you would need to ask the lender how they worked out the APR.

These articles may be useful:

APR

http://www.fsa.gov.uk/consumer/04_CREDIT_DEBT/mn_apr.html

AER

http://www.fsa.gov.uk/consumer/11_LEARN/financial_products/Saving/DASummary.html