Actual interest rate is the actual rate at which you will be repaying your loan. In this example we will use car loans to explain Actual interest rate. Based on the term of the loan, typically this interest rate is different from the original rate offered by car loan providers.
When you are looking at a car finance deal, you will be given a rate of interest. For example, a smart sales agent may offer you a flat interest rate of 5%. However, the salesman may not mention the actual interest rate, which will be much higher than 5%. This is especially true in the case of longer-term loans. That is because interest rate is calculated on the total principal for the entire loan period.
For example, you may take a loan of £10,000 at a rate of 5% for a period of 48 months. The monthly installment on this amount will be £230.29. Including interest, at the end of the 48-month period your total amount borrowed will be £11053.92 (£230.29x48). Thus, your total interest paid is £1053.92 (£11053.92-£10,000). If you calculate the actual interest rate, you'll realize that you will be paying interest at a rate of 10.54% (£1053.92 as a percentage of £10,000). This is happening because you were paying 5% on the principal amount of £10,000 for the entire 48-month period. Suppose you take this loan for a period of 60 months, you will end up paying interest at a rate as high as 13.23%.
Let's look at actual interest rate in the context of PCP finance. Suppose you want to buy a Vauxhall Corsa Diesel for £10,355.00 under PCP. The GMFV is £4,121.04; cash deposit is £1000, and other fees are around £335. Monthly installment is £143.92 for 48 months at a flat interest rate of 11%. At this rate, your total amount borrowed will be £6908.92 for the 48-month period. Of this amount, £2546 will be the total interest paid. If you calculate this amount of £2546 in relation to the original total to be repaid of £5568.96 (the car price plus other expenses less the deposit and GMFV), you will end up paying an actual interest rate of 24.06%, or more than double of 11%.
However, in case of shorter-term loans, you can repay your loan at a lower actual interest rate.
Let's say are interested in purchasing a Ford Focus priced at £14,300.00 under PCP finance. You want to settle this amount within one year at an interest rate of 5%. You are being offered a GMFV of £4121. Assuming your monthly installment is £871.40, your total amount borrowed will be £10456.80 in total (£871.40x12 months). In this case your total interest paid is only £277.80, which works out 2.73% of the total principal owed of £10179.
As seen from the examples, the actual interest rate can be quite high in comparison to the rate being offered by car loan providers. Dealers may offer attractive flat rates, and consumers get attracted to these low-interest rates. In order to avoid falling into this trap, it is always good to calculate actual interest rate on a new PCP deal.
We have provided you only some examples of calculating the actual interest rate. You can make your own calculations using our free PCP loan calculator.