It’s the ultimate financial enigma: APR vs. interest rate. And it has even the most financially literate of us asking some pressing questions: Are interest rates and APR the same thing? What’s the difference between them? What is an APR anyway? And what does it stand for?
We’re here to demystify the APR vs. interest rate question once and for all by breaking down each term and explaining how (and why) they’re not the same thing.
What is an interest rate?
An interest rate is how much a lender charges you to borrow money. It’s a percentage of your principal — the amount you’ve borrowed — that you pay every year. There are a number of factors that determine your loan’s interest rate, but chief among them is your credit score. The higher your credit score, the lower your interest rate.
What is APR?
Short for annual percentage rate, your APR is the yearly cost of your loan. It includes your interest rate, but also incorporates prepaid finance charges, like loan origination fees. Because it includes these fees and charges, your APR may be higher than your loan’s interest rate.
APR vs. interest rate
People often mix up APR and interest rate, and it’s easy to understand why. Both your loan’s interest rate and your APR are expressed in percentages. Both also represent how much a lender charges each year for borrowing money. But your interest rate is just one element of your APR, which includes fees and charges. APR is important because it gives you a better understanding of how much you’ll actually pay each year for your loan.
Why are my APR and interest rate different?
Once you start applying for loans, or start exploring options with a personal loan calculator, you may notice that an interest rate and APR are often different. In fact, you’ll typically see your APR is higher than your interest rate. That’s because your APR includes other charges, such as loan origination fees, and factors in the length of your loan. When you compare lenders, the APR can be used to get a clearer comparison of total costs.
Is my APR determined by my credit score?
No. Unlike your interest rate, which is mainly based on your credit score, your APR is determined by other factors, such as loan fees, charges and the length of your loan. While your interest rate is a big part of your APR, it’s not the determining factor.
You finally know the difference between APR and interest rate. And we’re guessing it wasn’t nearly as complicated as you thought. Armed with your new knowledge, you’re ready to find the very best interest rate and APR for your budget.