How reliable are APRs?

In another thread, dublinli said, of NIB's ECB + 0.5% tracker...

with current ecb rates of 4 per cent, their apr works out at 4.61.

Click to expand...

Contrary to popular opinion on Askaboutmoney, I don't think that APRs are a reliable method of comparing interest rates because I don't believe there's an industry-standard method of calculating them. Take this example - if the rate is always going to be ECB + 0.5%, then the APR should be 4.5% also?

If not, then the extra 0.11% per year must represent fees and charges. What fees and charges? On a sample mortgage of €250,000 over 25 years, the difference between 4.5% and 4.61% over the term of the loan is over €3,750.

I would presume that lenders don't include the cost of legal fees or valuations in the APR calculation because they will vary depending on which firms the client uses and so are outside the control of the lender. Being a variable rate loan secured on the family home, there's no penalty for redeeming the loan.

I don't believe APRs factor in possible future rate increases as that would be speculative.

Not singling out NIB - all lenders do it - Bank of Scotland's ECB + 0.55% tracker has a nominal rate of 4.55% but an APR of 4.65%. Their "additional charges at 0.1% are cheaper than NIBs.

So why is the APR on a tracker greater than the nominal rate?

Hi Liam

It's been discussed extensively here.

The reason APR is so important is that expensive lenders try to get borrowers thinking in terms of repayments. So if one borrower is charging 5% on a ten year loan, a borrower charging 7% over 20 years will charge a lower repayments figure, and the punter will think it's cheaper.

It really protects the consumer if we can get people to compare APRs rather than repayments. It's a single comparable figure. It might not be perfect and someone borrowing €250,000 in today's money might end up paying €3,750 over the next 25 years which is really tiny when discounted to today's figures. Most loans are repaid over 7 years, so the potential error in APR is far less than the potential misleading by talking repayments per thousand

Brendan

Hi Brendan,

Was I really still waffling on Askaboutmoney back in 2001? That CM chap in that post sounds dodgy - glad he's no longer around.

I agree that APR is a more useful method of comparing mortgages than discounted CPTs or comparing apples with oranges like the "two different terms" example you give.

But wouldn't it be far more useful if there was a strict industry-standard formula for calculating it, that all advertisements had to abide by? As it stands, two lenders offering the same tracker variable rate can and do quote two different APRs although they both calculate daily interest. Which weakens its usefulness in my view.

If APRs were standardised and all lenders forced to use the same methods, it would be far more trustworthy.

Do lenders publish the formulae they use for calculating APR? I must admit I thought that they were all using the same approach and differences in the figures were down to differences in the cost not the formula!

The formula is published in The Consumer Credit Act, I think.

It's the interpretation which is slightly different.

If you have a few concrete examples, bring them to the attention of consumerinfo@financialregulator.ie and they will sort them out.

Brendan

They may do on request, but they certainly don't send them to brokers with the usual updates of rates publications.

Meaning of letters and symbols:
Kis the number of a loan
K'is the number of a repayment or a payment of charges
AKis the amount of loan number K
A'K'is the amount of repayment number K'
http://www.irishstatutebook.ie/images/a24y95p0681b.bmprepresents a sum
m is the number of the last loan
m' is the number of the last repayment or payment of charges
tK is the interval, expressed in years and fractions of a year, between the date of loan No. 1 and those of subsequent loans Nos. 2 to m
tK' is the interval expressed in years and fractions of a year between the date of loan No. 1 and those of repayments or payments of charges Nos. 1 to m'
i is the percentage rate that can be calculated (either by algebra, by successive approximations, or by a computer programme) where the other terms in the equation are known from the contract or otherwise.

Remarks
( a ) The amounts paid by both parties at different times shall not necessarily be equal and shall not necessarily be paid at equal intervals.
( b ) The starting date shall be that of the first loan.
( c ) Intervals between dates used in the calculations shall be expressed in years or in fractions of a year.

Simple really.