APR vs. Interest Rate: What’s The Difference?

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Joshua White
APR vs. Interest Rate: What's The Difference

When planning to take out a loan, you must have come across the terms “APR” and “Interest rate.” At first glance, it may seem that this is the same thing because in advertising, the second term, “interest rate,” is much more common, which is usually lower than the first and looks more presentable. But what’s the difference between APR and interest rate?

Both are essentially the cost of borrowing money. However, they are not the same. And understanding the differences when comparing APRs vs. interest rates can help you make a more informed decision.

When choosing a loan product, a potential borrower is primarily guided by the interest rate set by his lender. Students who are searching for a loan can choose between fixed and variable interest rates. In the end, they make their decision based on the student loan interest rate, but the cost of a loan depends not only on this indicator. Financial institutions often offer a minimum interest rate on loans to attract customer service. The main overpayment is hidden in additional payments – various commissions, insurances, etc. They must be taken into account when choosing a loan program.

Below we will tell you what annual percentage rate (APR) and interest rate are, how the calculations are made, and what to look for in the first place.

Key Takeaways

  • The interest rate is the fee you pay to borrow money. It is a percentage figure that lenders charge on the total loan amount.
  • The annual percentage rate is a broader charge for using a loan, which includes the interest rate, transaction fees, closing costs, and other fees.
  • The lender determines the interest rate, taking into account many factors. Such as your credit score, credit history, type of loan, loan terms, etc.
  • To better understand the total cost of your loan, we recommend comparing APR rather than the interest rate.

What Is APR On a Loan?

APR represents the true cost of borrowing. This is especially important in cases where the financial product offers extremely low-interest rates but comes with high additional costs (commissions and fees).

Therefore, even at low-interest rates, the total cost of a loan can be much higher.

When choosing a loan using an annual interest rate, the borrower chooses the loan with the lowest annual interest rate, which means that the selected loan has the lowest cost compared to other loans.

As the name suggests, the annual interest rate is quoted annually. This is the best rate to compare, as interest rates don’t consider additional costs to borrow money.

When using an annual interest rate, various costs charged by the financial institution are included in the calculation of the annual interest rate.

You сould pay for the following:

  • Origination fees.
  • Mortgage broker fees.
  • Lender’s fees.
  • Discount points.
  • Mortgage insurance premiums.
  • Closing costs.
  • Underwriting fees.

It is important to remember that not all lenders list all fees in an annual interest rate. Therefore, to clearly understand the final cost of your loan, ask the lender as many questions as possible when comparing offers.

How Is APR Calculated?

The process of APR calculation on its own is quite complicated. First of all, it is complicated by the fact that, in addition to the interest rate, you need to consider several other payments that can only be announced by the lender and depend on him.

If you have already tried to calculate all this on your own and realized that calculating the final amount of a bad credit loan is not as easy as you would like, we can make this task a little easier for you. Loan calculator is a simple way to calculate the total loan amount and the amount of each loan payment. This calculator is one of the basic tools in making good financial decisions. And most importantly, this tool is available to you completely free of charge.

The actual interest rate includes all costs the borrower will face in repaying the loan. The exception is a fine or penalty for late payment. This is because the bank does not know how timely the client will pay the loan. In order for the cost of the loan to stay within the declared value, it is necessary to comply with the terms of the contract strictly. If the borrower repays the debt ahead of schedule, it will save on interest.

Is APR the Same As Interest Rate?

In some cases, the interest rate may be the same as the APR. As is the case with credit cards, for example. However, in most cases, the APR will be higher than the interest rate. And the interest rate is rather a fraction of the APR. 

If the interest rate means the net price for borrowing money, then the annual interest rate is the broader price for using a loan. In the case of a mortgage, this cost includes some additional fees.

What Is Interest Rate?     

The interest rate is the percentage of monetary profit determined by the creditor bank, which the borrower must pay for the use of funds (credit) taken for temporary use. In simple terms, the interest rate is the payment to the bank for using its money.

The bank interest rate is a rate that is paid on top of the borrowed funds to the lender, whether it be a bank or a microfinance organization.

The amount of interest on a loan in different credit organizations is different. Therefore, it is practically impossible to meet the same interest rate, and it depends primarily on the appetites of the creditors themselves.

How Are Interest Rates Calculated?     

Your lender sets the interest rate. Interest rates can be higher than average for small loans and direct lenders. There are also many factors that affect the interest rate. First of all, it is your credit score. The lower it is, the higher the interest rate will be. Thus, the lender tries to ensure the safety of his money, not being sure of the solvency of the borrower.

Some tips to improve your credit score:

  • Analyze your credit history. If you notice inaccurate data, apply for a change;
  • Pay your bills and try to make all monthly payments on time;
  • Stick to an active debt repayment schedule;
  • Check your credit score monthly to keep track of changes;
  • If you plan to apply for a loan that requires a good credit score, refrain from taking out new loans during this period of time.

It is not surprising if several different lenders offer you different interest rates and loan terms. However, when forming an interest rate, the lender also takes into account such concepts as current market interest rates and real estate economy conditions when calculating your rate.

What Is The Difference Between Interest Rate And APR?     

Earlier, we have already discussed what the interest rate and the APR are. The difference between them is that if the interest rate is the cost of using a loan, then the APR is a broader concept that includes a number of different payments provided for by the type of loan.

Since APR includes your interest rate and other fees connected with your loan, your APR will reflect a higher number. You can also consider APR to be your effective rate of interest.

Is It Better to Have a Lower Interest Rate Or Lower APR?

This question is most relevant for large and long-term mortgages.

In this case, you need to decide what is more important to you: smaller regular payments or a lower total cost of the loan that you have to pay.

If you understand that you won’t be able to handle large monthly payments, you should consider options with the lowest interest rates. However, in this case, the final cost of your loan may be higher.

The Bottom Line On APR Vs. Interest Rate

To summarize, while your interest rate is the percentage of interest you pay on a loan, your APR includes your interest rates along with any other fees or expenses you’ll pay your lender. The most common additional fees are brokerage fees, private mortgage insurance, and discount points. The APR shows us a complete picture of the total cost of the loan, so it should be oriented in the first place when comparing offers from lenders.

The interest rate and APR are not secret information; your lender is obligated to tell you all these figures and provide any information you request. You have the right to know what the final amount of the bond will be before signing the documents. While you can lower your interest rate by increasing your credit score, the APR depends on your lender and their fees.

Therefore, the best way out is to compare exactly the annual interest rate if you choose from a number of similar offers.

Thus, comparing APR vs. interest rate, we can say that although they are different concepts, they are often inseparable from each other, especially when it comes to large loans that involve long repayments. Such as a mortgage loan.