What is the Difference Between Interest Rate and APR?

Understanding the differences between the interest rate and Annual Percentage Rate (APR) may be confusing, but it's really important when you're thinking about borrowing money.

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

What is an interest rate?

The interest rate on a loan or line of credit 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.

There are several factors that determine your loan’s interest rate, but the most important among them is your credit score. The higher your credit score, the better your chances of qualifying for lower interest rates.

What is APR?

Your APR is the yearly cost of your loan. It includes your interest rate as well as prepaid finance charges, like loan origination fees, finder's fees and appraisal fees. Because it includes these fees and charges, your APR may be higher than your loan’s interest rate. The purpose of the APR is to help you compare offers with complex terms. When consumer credit companies 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

Interest rate vs APR

People often mix up the APR and interest rate, and it’s easy to understand why. Both your loan’s interest rate and your APR are shown in percentages. Both also show how much a lender charges each year for borrowing money. Interest Rate:

• 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):

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

Key Differences:

• Interest rate focuses just on the cost of borrowing money, while APR includes all costs associated with the loan.
• APR is typically higher than the interest rate because it includes fees and other charges.
• Interest rate is used to calculate interest payments, while APR is used to compare the overall costs of different loan options.

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.

Is my APR determined by my credit score?

APRs and interest rates are calculated differently. Unlike your interest rate, which is mainly based on your credit score, your APR is made up of other factors, such as loan fees, charges 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.

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.

Sources:

1 https://www.indeed.com/career-advice/career-development/how-to-calculate-apr

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