Understanding APR: Why High-Risk Loans Carry Higher Rates

Last Updated on 19 February 2026

If you have ever compared loan products and noticed that the interest rates on offer vary enormously depending on the lender and the type of borrower being targeted, you have observed one of the most fundamental principles in financial economics: risk-based pricing. The Annual Percentage Rate, almost always referred to simply as APR, is the standardised measure that allows borrowers to compare the cost of credit across different products and providers. But understanding why APR varies so widely between different types of loans requires a short excursion into the mathematics of lending, and that excursion turns out to be genuinely illuminating about how credit markets work and why some borrowers pay considerably more than others for what appears to be the same product.

At its most basic level, APR represents the total annual cost of borrowing expressed as a percentage of the amount borrowed, including interest and any mandatory fees. A loan with an APR of 10% will cost you ten pounds in interest and fees for every hundred pounds borrowed over the course of a year, assuming a simple interest structure. In practice, most consumer loans use compound interest and involve monthly repayments, which makes the precise mathematical relationship between APR, the monthly rate, and the total amount repayable slightly more involved, but the core concept is the same. APR exists as a standardised metric precisely because different lenders used to quote interest in different ways, making genuine comparison almost impossible, and its widespread adoption has made the consumer credit market considerably more transparent than it once was.

The Mathematics of Risk and Return

To understand why different borrowers are charged different APRs, it helps to think about lending from the lender’s perspective. When a lender extends credit to a borrower, they are making a probabilistic bet. Most of the time, the bet pays off: the borrower repays in full and on time, and the lender earns the interest they anticipated. Occasionally, the bet does not pay off: the borrower defaults, and the lender recovers less than the full amount owed, or nothing at all. The lender’s job is to price their loans in a way that the interest income generated across the whole portfolio of loans is sufficient to cover the cost of the defaults within that portfolio, the cost of funding the loans in the first place, operational costs, and a margin that makes the business viable.

This means that APR is not set arbitrarily, it is a direct function of the expected default rate within a given risk category. If a lender’s historical data tells them that borrowers in a particular risk tier default at a rate of, say, five percent, they need to price every loan in that tier at a level where the interest income from the ninety-five percent who repay successfully is sufficient to cover the losses from the five percent who do not, plus all other costs. As the expected default rate rises, the required APR rises with it, because the profitable loans must work harder to subsidise the losses from the unprofitable ones. This is the mathematical foundation of risk-based pricing, and it applies across the entire lending industry from mortgages to credit cards to personal loans.

What This Means for Borrowers With Imperfect Credit

For borrowers with a strong credit history, mainstream lenders are competing to offer the most attractive rates because the statistical risk of default is low and the economics of lending to them are favourable. For borrowers with a thinner or more troubled credit history, the expected default rate is higher, which means the APR required to make lending to them economically sustainable is also higher. This is not a moral judgement about the borrower’s character or intentions, it is a purely mathematical consequence of the risk profile of the population they belong to based on available data. A borrower who has missed payments in the past is statistically more likely to miss payments in the future, even if their current circumstances are entirely stable, because that is what the aggregate data across millions of similar borrowers shows.

Understanding this helps explain both why loans for bad credit carry higher APRs than mainstream products and why those higher APRs are not simply the result of lenders exploiting vulnerable customers. The cost of lending to higher-risk borrowers is genuinely higher, because the losses that must be absorbed are greater, and a lender who did not price for those losses would quickly find themselves with an unviable business. What regulation seeks to ensure, and the FCA’s Consumer Duty reinforces this, is that the premium charged above and beyond the genuine risk cost is not excessive, that pricing is transparent and fair, and that borrowers are not placed into products they cannot sustainably afford. The mathematics of risk must be balanced against the ethics of fair access to credit, and the best lenders in this space take both seriously.

For borrowers navigating the higher-APR end of the market, the most important practical step is to understand the total cost of borrowing, not just the monthly repayment figure. The total amount repayable over the life of a loan, which all regulated lenders are required to display prominently, gives you a clear picture of what the credit will actually cost you in pounds and pence. Comparing this figure across different products, rather than comparing monthly payments in isolation, is the most reliable way to make an informed borrowing decision. And wherever possible, working to improve your credit profile over time, through consistent repayment behaviour, ensuring you are on the electoral roll, and reducing outstanding debt, will gradually move you into lower-risk pricing tiers where the cost of credit is substantially reduced.