APR vs Interest Rate: What’s the Real Cost of Borrowing?

When comparing loans, you’ll see two key numbers: the interest rate and the APR. They sound similar, but they measure different things—and choosing a loan based on the wrong one can cost you hundreds of pounds.

This guide explains the difference between APR and interest rate, shows you how each is calculated, and helps you spot the true cost of borrowing.

What is an interest rate?

The interest rate is the cost of borrowing the principal, expressed as a percentage per year. It does not include fees or charges.

Example:

You borrow £10,000 at a 7% interest rate for 3 years.

Interest charged = £10,000 × 7% × 3 years = £2,100

But you might also pay:

• Arrangement fee: £150
• Late payment charge: £25 (if applicable)
• Early repayment penalty: 2% of balance (if applicable)

The interest rate doesn’t show these costs—so it’s not the full picture.

What is APR (Annual Percentage Rate)?

APR is the total cost of borrowing expressed as a yearly percentage. It includes:

• The interest rate
• Mandatory fees (arrangement fees, booking fees, etc.)
• Compounding effects (interest on interest)

APR shows what you’ll actually pay over the loan term. It’s designed to make comparing loans easier because it accounts for fees, not just interest.

The same loan with APR:

Loan: £10,000 at 7.5% APR for 3 years

• Monthly payment: £310.35
• Total repaid: £11,172.60
• True cost: £1,172.60

The APR includes the arrangement fee in its calculation, giving you a more accurate picture than the interest rate alone.

Why APR matters more than interest rate

Lenders can advertise low interest rates to make loans look cheap, then add fees that increase the real cost. APR cuts through this by showing the total cost.

Real UK example:

Loan A:

• Amount: £5,000
• Interest rate: 6.5%
• Arrangement fee: £0
• APR: 6.5%
• Total repaid: £5,508.77

Loan B:

• Amount: £5,000
• Interest rate: 5.9%
• Arrangement fee: £199
• APR: 7.8%
• Total repaid: £5,606.19

Loan B has a lower interest rate but a higher APR because of the fee. You’d pay £97.42 more with Loan B.

Always compare APRs, not just interest rates. Compare loans side-by-side to see the true cost.

How is APR calculated?

APR accounts for:

1. The interest rate (cost of borrowing the principal)
2. Mandatory fees (arrangement fees, booking fees, valuation fees, etc.)
3. Compounding (interest charged on unpaid interest)

The calculation uses the same payment formula as standard loans, but includes fees as part of the loan amount.

Simplified APR formula:

APR = [(Total repaid - Amount borrowed) / Amount borrowed] / Loan term (years) × 100

This is a rough approximation—actual APR uses iterative calculations to account for monthly compounding.

What fees are included in APR?

Included in APR:

• Arrangement or origination fees
• Booking fees
• Valuation fees (for secured loans)
• Mandatory insurance (if required by lender)

NOT included in APR:

• Optional insurance (payment protection, life insurance)
• Late payment charges
• Early repayment penalties
• Missed payment fees

APR assumes you make all payments on time and keep the loan for the full term. If you repay early or miss payments, your actual cost may differ.

Representative APR: what it means

UK lenders advertise a representative APR, which is the rate offered to at least 51% of accepted applicants.

This means up to 49% of borrowers get a higher rate based on their credit score.

Example:

Lender advertises: 6.9% representative APR

You might be offered:

• 6.9% if you have excellent credit
• 9.9% if you have good credit
• 14.9% if you have fair credit
• Declined if you have poor credit

Never assume you’ll get the advertised rate—check what APR you’re offered before committing.

Fixed APR vs variable APR

Fixed APR

The rate stays the same for the entire loan term. Your monthly payment never changes.

Pros:

• Predictable budgeting
• Protection from rate increases
• Peace of mind

Cons:

• Slightly higher than initial variable rates
• No benefit if rates fall

Best for: Most UK personal loans, especially if you value certainty.

Variable APR

The rate can change based on the Bank of England base rate or lender’s standard variable rate (SVR).

Pros:

• Often starts lower than fixed rates
• You benefit if rates drop

Cons:

• Monthly payment can increase
• Harder to budget
• Risk of unaffordable payments if rates rise

Best for: Borrowers who can afford payment volatility and expect rates to fall. Model variable rate scenarios to see the risk.

How to compare loans accurately

Step 1: Look at the APR first

APR shows the true cost, including fees. Ignore headline interest rates—they’re often misleading.

Step 2: Check the total amount repayable

This is the bottom line: how much will you actually pay back over the loan term?

Step 3: Confirm what rate you’ll get

Apply for a quote (not a full application) to see your personalised APR based on your credit score.

Step 4: Read the fine print

Check for:

• Early repayment charges
• Late payment fees
• Overpayment restrictions

Even a low APR isn’t a good deal if the terms are inflexible.

Compare multiple loans with our side-by-side calculator to find the best option.

Real UK loan comparison

Let’s compare three real offers for a £8,000 loan over 36 months:

Lender	Interest Rate	Fees	APR	Monthly Payment	Total Repaid	Total Cost
Lender A	7.9%	£0	7.9%	£251.19	£9,042.84	£1,042.84
Lender B	6.9%	£150	8.4%	£251.94	£9,069.84	£1,219.84
Lender C	8.9%	£0	8.9%	£254.50	£9,162.00	£1,162.00

Lender A has the best APR and lowest total cost despite not having the lowest interest rate.

Lender B looks good at 6.9% interest, but the £150 fee pushes the APR above Lender A.

When interest rate matters more

In a few specific cases, the interest rate is more relevant than APR:

Very short-term loans (under 6 months)

APR is annualised, so it can exaggerate costs on very short loans. Check the total amount repayable instead.

Loans with optional fees

If a fee is optional (like payment protection insurance), it’s not included in APR. You can opt out and lower your true cost.

Comparing credit cards

Credit cards quote APR, but the interest rate matters more if you carry a balance month-to-month (because cards charge interest on the outstanding balance, not the original amount).

Red flags to watch for

“0% interest” (but high fees)

Some lenders advertise 0% interest but charge massive arrangement fees. The APR reveals the true cost.

“Representative APR” far from actual APR

If you’re offered an APR much higher than advertised, your credit score may not qualify you for good terms. Shop around.

Missing APR entirely

If a lender doesn’t display APR clearly, avoid them. Reputable UK lenders must show APR by law.

Put it into practice

APR is the most reliable way to compare loans because it includes fees and shows the true cost of borrowing. Always prioritise APR over interest rate when choosing a loan.

Before borrowing:

• Calculate the true cost with APR, fees, and term length
• Compare multiple lenders to find the lowest APR
• Check your personalised rate before committing

For more practical finance guides, explore our guides.