What is the Difference Between APR and Interest Rate?

Understanding the differences between the interest rate and annual percentage rate (APR) may be confusing, but it's important when you're thinking about taking out a loan.

The two terms might seem similar, but they mean different things when it comes to loans. Keep reading for a breakdown of what interest rates and APRs are, why they matter and how they can affect your finances.

What is an interest rate?

The interest rate on a loan is the cost of borrowing money. The amount of money you pay in interest is based on the principal — the amount you’ve borrowed — that you pay every year.

Your credit score plays an important factor in determining your loan interest rate. The higher your credit score, the better your chances of qualifying for lower interest rates.

A fixed interest rate means the rate you pay stays the same for the length of the loan. An interest rate that increases or decreases over time is known as a variable interest rate.

What is APR?

The APR is the yearly cost of a loan. It includes the interest rate as well as prepaid finance charges, like loan origination fees, finder's fees, and appraisal fees. The purpose of the APR is to help you compare offers with complex terms. When consumer lenders advertise the APR, federal law requires them to calculate it with a standardized method.

That formula is: APR = ((Interest + Fees / Loan amount) / Number of days in loan term)) x 365 x 100.¹

APR vs interest rate

People often mix up the APR and interest rate, and it’s easy to understand why. Both your loan interest rate and your APR are shown in percentages. Both also show how much a lender charges for borrowing money. However, the interest rate is used to calculate interest payments, while the APR is used to compare the overall costs of different loan options.

Here are some other key differences to remember:

Interest rate

The interest rate is the basic cost of borrowing before any added fees:

• The interest rate is the amount charged by the lender on the principal amount.
• It represents the cost of borrowing money, usually shown as a percentage.
• The interest rate does not include additional fees that come with the loan.

Annual percentage rate (APR)

The APR gives you a fuller picture of what a loan costs and is useful for comparing offers:

• The APR is the total cost of borrowing, including interest and fees, expressed as an annual percentage.
• The APR includes the interest rate and any additional costs such as origination fees, closing costs and points, depending on the type of loan.
• The APR provides a full picture of the loan's true cost compared to the interest rate alone.

Why is the APR typically higher than the interest rate?

The APR is typically higher than the interest rate because it includes fees and other charges. Along with the interest rate, the APR also factors in fees and finance charges. Since the interest rate only reflects the cost of borrowing the principal, it tends to be the lower of the two numbers. Looking at the APR gives you a more complete picture of what a loan costs.

APR CAN BE TRICKY. WE CAN HELP.
Considering a personal loan? Use our personal loan calculator to estimate monthly payments. Just plug in an APR, how much you want to borrow, and we’ll do the rest.

Does my credit score determine my APR?

Unlike your interest rate, which is mainly based on your credit score, your APR is made up of other factors, such as loan fees and the length of your loan. However, your credit score still plays a key role in determining the final APR that applies to your loan.

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Learn the difference to reach your money goals

Once you take a closer look, the difference between interest rate and APR isn’t that complicated after all. Armed with your new knowledge, you may be ready to find the very best interest rate and APR for your budget.

This article has been updated since the original posting in 2022. Jessica Leshnoff and Kim Gallagher contributed to this post.

Source

1 https://www.investopedia.com/terms/a/apr.asp

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