If you have ever taken out or considered taking out a short-term loan, such as a payday loan or instalment loan, to help cover an unexpected emergency expense, you may have come across a number of technical terms within the loan’s terms and conditions that are difficult to understand.
Assessing the terms of a short-term loan should not be complicated – and if you think they are, then this blog is a must-read. This blog will explain the terminology used in the high-cost short-term credit industry, as well as explaining APR (Annual Percentage Rate), interest rates and other “jargon”, to help you make an informed decision and highlight what to look out for when comparing the loan terms of each lender.To find out what else you should consider before applying for a short-term payday loan, download our eBook now. It's free!
Explaining High Cost Short Term Credit and the industry-wide price cap
High Cost Short Term Credit (HCSTC) is an unsecured, regulated credit agreement where APR is equal to or exceeds 100% and the credit is substantially repayable within 12 months from the date it is advanced.
In January 2015, the Financial Conduct Authority (FCA) introduced a price cap on daily interest for high-cost short-term credit products of 0.8% per day of the amount borrowed. In addition, fixed default fees are capped at £15 and there is a total cost cap of 100%, meaning borrowers never have to pay back more than double of the principal amount borrowed.
APR and interest rates explained
What are APR and Representative APR?
APR is the most common measure used to compare the cost of financial products. APR is expressed as a percentage and represents the actual yearly cost of funds over the term of a loan. For example, if you were to borrow £100 with an APR rate of 10%, you would have to pay £110 – this includes the £100 borrowed and the additional £10 of interest.
Representative APR is the rate of APR that is advertised and available to at least 51% of successful applicants that apply. Uncle Buck’s representative APR is 1,253.4%. Representative APR must be displayed by lenders as it allows you to compare other products easily and fairly. However, while APRs are useful to help compare the costs of loans over similar time frames, you can’t, for example, compare the cost of a 25 year mortgage and a 5 year personal loan by looking at the APR.
Understanding fixed and variable interest rates
A fixed interest rate means that throughout the entirety of your loan agreement, the rate applied will stay the same throughout your loan term and never go up or down.
A variable interest rate (also known as a floating or adjustable rate), however, is tied to an index or benchmark rate, such as the Bank of England’s base rate for example. There are two main types of variable interest rate: standard variable rate or a tracker rate.
Standard variable rates
The standard variable rate is fixed by the lender – who can increase or decrease it at any point – and roughly follows a benchmark base rate (Bank of England’s base rate). If the benchmark rate falls, the lender can either raise or reduce your current rate if they so wish. For example, if the base rate went up by 1%, your lender could choose not to increase the standard variable rate or decrease it.
Tracker rates, on the other hand, are guaranteed to rise and fall with the benchmark rate (Bank of England’s base rate). The tracker rate is not necessarily the same as the base rate and is normally above it – the tracker rate just moves in line with it, so if the Bank of England’s base rate rises or falls, so too does the interest rate on your loan.
If you need more help calculating the cost of your loan over 12 months and with APR, interest and fees considered – please use our online loans calculator. If you need more information on the terminology used throughout the high-cost short-term credit industry, we have a comprehensive glossary which addresses the pertinent terms here.
Having explained APR and interest rates, you should be in a good position to weigh up potential lenders – but assessing the terms of a short-term loan and how they will affect your ability to repay is just one thing to take into account before applying.
To discover what else is important to consider beforehand, download our latest eBook for free.