'Typical' Rates Are Hardly Typical!

Saving and Making Money

04 May 2006 | 0 Comments

When applying for credit, you may not qualify for the heavily advertised 'typical' rate. In reality, you could pay much higher rates.

When you see an advertisement for credit, do you understand what 'typical APR' after the headline interest rate means?APR stands for Annual Percentage Rate, which is the standard way of showing the cost of borrowing, taking into account interest and other charges for credit. The APR also takes compounding (interest charged on interest) into account, so a credit card with no annual fee and a monthly interest rate of, say, 1.5% would have an APR of more than twelve times 1.5%. (In fact, the APR in this example is 19.6%, which is 1.015 multiplied by itself twelve times, minus 1).That's the APR taken care of; now what about the 'typical' part? 'Typical APR' indicates that the lender uses risk-based pricing: in other words, it awards you a tailored rate based on your personal financial circumstances, past credit history, and so on. A high credit score will secure you the best interest rate, whereas a below-par score will mean paying a higher rate or having your application rejected.In theory, for a typical APR to be valid, the lender must offer this headline rate to two out of three borrowers (66%). However, in practice, there is no independent regulation of this requirement, which leaves lenders free to manipulate this process to their advantage. For example, I know of one leading provider of personal loans which rejects seven out of ten applicants, then awards its typical APR to two of the remaining three lucky borrowers. Although it meets the letter of the 2/3rds rule, in effect, only one in five borrowers (20%) actually receives its (far from) 'typical' rate!Indeed, independent financial researcher Moneyfacts is becoming increasingly concerned at the widespread use of typical APRs. A growing number of lenders are switching to risk-based lending, particularly with personal loans and, to a lesser degree, credit cards. For instance, Sainsbury's Bank has adopted risk-based pricing for its credit cards, plus Egg has embraced this pricing structure for its personal loans.According to Moneyfacts, four-fifths (80%) of all personal-loan providers now use typical rates, compared to just over a third (35%) of credit-card issuers. Then again, Cahoot is the only current-account provider which uses risk-based pricing for overdrafts, with APRs ranging from 9.8% to 14.8% (11.8% typical APR).Of course, 'pricing for risk' creates problems for consumers who shop around for cards or loans, particularly those applicants who are attracted to a headline rate, only to be offered a higher rate or have their application rejected outright. Each of these applications leaves a 'credit search' marker on their credit reference, and too many of these markers can make applying for credit an uphill struggle.Hence, risk-based pricing may actually discourage consumers from shopping around, which has to be a bad thing. Worryingly, Moneyfacts expects more and more lenders to implement risk-based pricing to raise their interest income, partly in response to rising bad debts and regulatory pressure on penalty charges and other steep fees.So, if you're not confident that your credit rating is A1, or you don't think that your customer profile will match a particular lender's scorecard, you can always look around for cards and loans which charge all borrowers the same rate, regardless of their personal circumstances. You'll find plenty of great deals in our Credit Card and Personal Loan centres.Finally, don't be disheartened if you are rejected for credit. Despite having a large portfolio of cash and shares, and not having any debts other than a 'paid in full each month' credit card, I'm frequently rejected for credit. I guess it's because I'm a 'rate tart', constantly jumping from one 0% deal to the next, leaving banks nursing losses in my wake!More: Check out these great rates for credit cards and personal loans | Check your credit report

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