APR, AER and EAR are terms used in financial advertising. What do they mean?
By Michael Challiner
Have you ever scanned the acres of financial advertising and wondered what APR, AER and EAR really mean? You'll invariably find one or another of these terms in every advertisement for a lending or savings product. Well you're certainly not alone.
The Financial Services Authority lays down the exact formulas for calculating APR, AER and EAR's. Every UK financial institution then has to stick by the formulas and the FSA lays down rules as to when and how the figures have to be disclosed. There are no exclusions! Errors invariably result in big fines for the offending company and compensation for any borrower or saver affected. But it's still no good if the public simply don't understand what the terms mean.
So here's our bit to lift the mists of misunderstanding!
APR is most commonly seen. It stands for "annual percentage rate" and is used to express the true cost of the money borrowed on credit cards, loans and mortgages. The APR calculation takes account of the basic interest rate, when it is charged (i.e. annually, monthly, weekly or daily), all initial fees and any other costs you are obliged to pay. As lenders all calculate APR the same way, it enables you to make direct cost comparisons between competing lending products.
So if one bank is offering you a mortgage at 4.75% plus an arrangement fee of £450 and a building society is offering you an interest rate of 5.1% with a £100 fee, then the APR figures will show you which of the two mortgages is the cheaper.
There are then two further expressions you'll see that include the term APR. X% APR variable means that the borrowing cost is currently X% but the rate of interest is not fixed and is likely to vary (up or down).
The second is X% APR Typical variable. You'll regularly see this expression in loan promotions. It means that the lender cannot be specific about the interest rate you'd be charged as their rates vary, usually in response to your personal credit history and the amount of money you want to borrow. Therefore X% APR Typical variable, is used to provide a general impression of the interest rate you can expect to be offered. The addition of the word "Typical" means that at least two thirds of applications that the advertiser approves are at that APR or cheaper . Then if a loan is offered to you, the paperwork will reveal the actual APR or APR variable you are being offered.
Now lets turn our attention to EAR. EAR is the abbreviation for "equivalent annual rate". It's used to demonstrate the full percentage cost of overdrafts and accounts that can be in credit and also go overdrawn. The calculation accurately illustrates the cost of the overdraft facility. In common with the APR calculation, EAR takes into account of the basic rate of interest charged, when the interest is charged, plus any additional charges. So in most respects EAR and APR do the same thing – it's just that APR applies to pure lending products whilst EAR applies to a product, such as a banking current account, that can be held in credit or go overdrawn.
Incidentally, the EAR and APR figures always exclude any Payment Protection Insurance you've bought to guarantee that the monthly repayments will be maintained if you're off work due to accident, sickness or unemployment. That's because this insurance is always an optional extra and is never a condition of the lending.
AER on the other hand is only used in relation to savings and interest based investments. It's concerned with the rate of interest you'll receive on your money. AER is short for "annual equivalent rate". It shows the adjusted rate of interest you'll receive at the end of a twelve-month period taking into account the regularity of which interest is credited to the account. (This is necessary as the frequency of payment has a compounding affect on the amount of interest you actually receive). The formula for AER also removes the affect of any promotional offer that disappears after a few months – a popular ploy used by financial institutions to send their savings products to the top of the Best Buy lists.
You'll probably forget most of this as it's yawningly boring but we hope we've shed light on some of the most important financial jargon you're faced with!
About the Author
Michael writes for Brokers Online who offer life insurance policies and most UK financial services including secured loans and loan and mortgage payment protection insurance.
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