Interest "p.a." as opposed to "APR"

Matt_EA

In the usual post-Xmas CC offers blitz, HBOS have sent me some credit card cheques offering "6.95% p.a." for the life of the balance (plus a 3% handling fee so I'm not sure if it's worth it). My balance with them is zero so I'm thinking about using it to clear £2.5K from another card which is 16.9% APR.

My question is, what's the meaning when interest is expressed as a percentage "p.a." as opposed to the usual percentage "APR"? (btw I know p.a. is per annum!)

I see this more and more and wonder if there's anything fishy about it, or if it just means the same thing?

Astaroth

APR is a defined way of calculating interest including any fees and based on borrowing £1500 (if memory serves correct) over 12 months making minimum payments.

The two figures are different - personally I much prefer PA as APR can look really silly when you either consider short term lending or large fee based lending.

Robert_Sterling

Try this for size
You borrow £100
On day one you pay a £3 charge
Thus you actually get £97
The interest rate is 6.95% p.a.
So after one year you pay £100 + £6.95 = £106.95
For the purpose of APR calculation you say that
you borrowed £97 and repaid £106.95 a year later.
So on £97 you paid £9.95 interest after one year.
£9.95 is 10.26% of your £97
So the APR is 10.26%
The APR is useful for comparing loan offers.

What this example shows is that if you could get a loan at 10% or less
it would be at a lower rate than the 6.95% with a 3% on day one fee.

Mortgage lenders like to keep their head lin rates low by using high arrangement fees.
However by law they are compelled to advertise the APR in a font at least as large as that used for the interest rate.

Matt_EA

Thanks Robert, that helps me understand... APR expresses the total cost of the credit, okay.

Robert_Sterling

Yes that was the original intention.
.....................................................................................................
However the mortgage lenders have found a way of avoiding using the APR in a sensible way.

Here is how they do it.

They offer a loan at a "low" rate of interest for two or three years only.
They have a large arrangement fee.
In theory they charge a significantly higher rate for the remaing 20 or more years of the mortgage.
However the astute customer strikes a new deal after the initial rate expires.
The lender calculates the original APR on the assumption you will stay with the mortgage for 25 years.
They then publish an APR which is much higher than you might have expected because you know that your actual rate of interest is quite low and you will be doing a new deal within two or three years.
As a result of these two factors you ignore the APR quoted.

Meanwhile you may think you are only paying 5%
At first sight this is correct.
This overlooks the arrangement fee.
It has been fed into the APR calculation for a 25 year loan.
As a result the fee does not raise the APR much and the borrower ignores it anyway.

I advocate that the APR should be calculated for the initial period of the loan only. i.e. The first two or three years.
During this period the arrangement fee makes a considerable impact on the psuedo APR which I have defined.

There is not much hope of improving the application of the APR rules.
They were first formulated in the Consumer Credit Act of 1975.

MarkyMarkD

I think that you are a bit harsh on lenders, Robert. The lenders are required to state the APR over a sensible period. As most people take out mortgages for 25 years, they tend to quote APRs over 25 years. It would be called mis-leading to express the APR over a shorter period, which would almost always show a lower APR.

That said, I agree with you that the "pseudo APR" you describe is a more useful one. When KFIs (Key Fact Illustrations) for mortgages were introduced, it should have been made a requirement to ask the customer how long they intended to keep the mortgage for, and to state the APR over that period as well as the nominal term. This would then mean that competitors' mortgage quotes could be compared in a meaningful way.

It is easy enough for anyone who can use Excel to calculate their own "pseudo APR" and that's how I personally compare mortgages. I'm sure you also can do the same.

Astaroth

But then the whole APR thing is overly simplistic and complicated almost at the same time.... look at "black" credit cards which often have a high annual fee unless you spend over £X a month... APR has to be calculated on a balance of £1500 (for credit cards anyway) and so having an annual fee of £500 will give you a silly APR even more so when you consider that 95% of customers never pay the fee as they easily spend over the threashold.

Robert_Sterling

MarkyMarkD wrote

"I think that you are a bit harsh on lenders, Robert. The lenders are required to state the APR over a sensible period."

Exactly. So if somebody takes a five year fixed rate a sensible period to use for the calculation of the APR is clearly five years and it is equally clearly, to me at any rate, not twenty five years. At the time of calculating the APR the lender does not actually know what rate he might charge after the five years have elapsed. It is almost true to say that what I have to call the Pseudo APR is in fact the true APR and what legally is called the true APR is in fact a Pseudo APR.

"As most people take out mortgages for 25 years, they tend to quote APRs over 25 years. "

What is your evidence for saying this.
What percentage of FTBs take out a 25 year mortgage and what percentage take out a shorter term discounted or fixed rate mortgage.
Do most of your FTB clients not take out a shorter term or fixed rate or discounted mortgage. If not why not as it appears to me to be the astute thing to do.

"It would be called mis-leading to express the APR over a shorter period, which would almost always show a lower APR."

It is misleading not to use the Pseudo APR precisely because the legal APR is misleading because it will almost always show a higher APR than is appropriate for the FTB's inital morgage condidtions. The legal APR is often so far from the Pseudo APR that it can be dismissed as only being shown because "red tape" regulations insist upon it in the face of all rational arguement against it.

"That said, I agree with you that the "pseudo APR" you describe is a more useful one."

I would be surprised if you did not.

"When KFIs (Key Fact Illustrations) for mortgages were introduced, it should have been made a requirement to ask the customer how long they intended to keep the mortgage for, and to state the APR over that period as well as the nominal term. This would then mean that competitors' mortgage quotes could be compared in a meaningful way."

Now you are talking turkey.

"It is easy enough for anyone who can use Excel to calculate their own "pseudo APR" and that's how I personally compare mortgages. I'm sure you also can do the same."

If only you knew !

MarkyMarkD

Robert_Sterling wrote:

MarkyMarkD wrote

"As most people take out mortgages for 25 years, they tend to quote APRs over 25 years. "

What is your evidence for saying this.
What percentage of FTBs take out a 25 year mortgage and what percentage take out a shorter term discounted or fixed rate mortgage.
Do most of your FTB clients not take out a shorter term or fixed rate or discounted mortgage. If not why not as it appears to me to be the astute thing to do.

I think you are taking my words the wrong way. Most people take out mortgages with a contractual repayment term of 25 years, but with a fixed or discounted rate over a term of 2, 3 or 5 years. Because the contractual repayment term is 25 years, it is considered reasonable for APRs to be calculated over that same 25 year term. Repayment at the end of the fixed or discounted term is considered "early" repayment under this approach.

Robert_Sterling

You may consider it reaonable to quote the APR over a 25 year period when nobody knows what the actual interest rate will be af ter the fixed rate period or even the discounted rate period ends but I do not think it is reasonable.

I am surprised to hear that you do think it is reasonable in spite of the fact it is based on the totally unwarranted assumption that the interest rate over the remaing period of a loan e.g. 20 years or so, will be the same as it was when the mortgage first started when we do not even know for sure what it wil be later this month.

MarkyMarkD

You are once again imputing things which I didn't say. I said "it is considered", not "I consider" - as I've previously posted, I think that at the very least a "pseudo APR" calculated over the customer's intended repayment period (not the contractual one, but the fixed/discounted term in many cases) should be included within mortgage illustrations.

But I can also see why lenders would represent APRs over the contractual term, as that's the only maximum term they have knowledge of up front and provides (in most cases) the highest APR.

Your point about variability of the "go to" rate is well made, but APR should only be used as a comparative tool and hence any mortgage product you are choosing between will likely be impacted in the same way by rate changes in the market as a whole ... meaning that assuming it will be the same as current "go to" rates is not as unreasonable as it may at first appear.