Whilst browsing through newspapers and Internet articles, most of us have seen the term APR in financial advertising and possibly its lesser-used cousins AER and EAR. But what do they mean? We explore the main terminology that you may come across. The Financial Services Authority (FSA) specifies the exact mathematics behind these calculations and policies use. All financial institutions have to stick to the exact calculations and the FSA lays down rules as to when and how the figures have to be disclosed. There is no exclusion.

APR stands for “Annual Percentage Rate” and is used to describe the true cost of the money borrowed on mortgages, loans, and credit cards. The calculation for APR takes into account the basic interest rate, when it is charged (i.e. daily, weekly etc.), all initial fees and any other costs you have to pay. As all lenders calculate APR exactly the same way, it enables you to make direct cost comparisons between lending products. So if one building society is offering you a mortgage at 4.8% plus an arrangement fee of £600 and a bank is offering you an interest rate of 5.2% with a £150 fee, then the APR figures will show you which of the two mortgages is cheaper.

There are then two further expressions that use APR. The X% APR variable, which means that the cost is currently X% but the interest rate is not fixed and from time to time the interest rate is likely to vary. You'll frequently see this expression, 'the X% APR typical variable', in promotions for loans. It means that the lender is not being totally specific about the interest rate you will be charged as their rates vary, usually in response to your personal credit rating and the amount of money you want to borrow. Therefore X% APR Typical variable is used to give you a general idea of what interest rate you can expect to pay. The addition of the word “Typical” means that at least 66% of their approved applications are offered that rate or cheaper. Then when a loan offer is confirmed to you, the paperwork will disclose the actual APR or APR variable you are being offered.

The second term to become familiar with is the EAR. EAR is the abbreviation for “equivalent annual rate”. It is used to illustrate the full percentage cost of overdrafts and any type of account that can be in credit and also go overdrawn. The calculation shows you the true cost if you use the overdraft facility. In common with the APR calculation, EAR takes account of the basic rate of interest and when the interest is charged to the account plus any additional charges. So in most respects EAR and APR achieve the same thing – it's just that APR applies to a pure lending product whereas EAR applies to a product, such as a bank current account, that can be in credit or go overdrawn. Note that the calculations for both EAR and APR always exclude any Payment Protection Insurance you've bought to ensure the monthly repayments are maintained if you are off work due to accident, sickness or unemployment because this insurance is always optional and is not a condition of the lending.

The third term used is the AER. AER is totally different – it is only used in relation to savings and interest based investments. It is all about the rate of interest you will receive on your money AER means “Annual Equivalent Rate”. It shows the true rate of interest you will have received by the end of the year taking into account the regularity of which interest is added to the account (as the payment frequency has a compounding affect on the amount of interest you receive). The AER calculation also removes the affect of any promotional offer that disappear after a few months - a popular trick used by banks and other institutions to boost their savings products to the top of the Best Buy tables Becoming familiar with these terms, is important so you have a clearer understanding of the cost of borrowing.