APR vs. Interest Rate: What Is the Difference?
Why two loans with the same interest rate can cost very different amounts, and how to compare them correctly.
Loan advertisements usually lead with a low interest rate. The number that matters more for comparing offers is the APR. The two are related but they are not the same thing, and mixing them up is one of the most common mistakes borrowers make.
What the interest rate measures
The interest rate is the percentage a lender charges on the amount you owe. It determines the interest portion of each payment, but it says nothing about fees you may pay to get the loan.
What APR adds
APR stands for annual percentage rate. In the United States, lenders must disclose it, and it expresses the yearly cost of the loan including certain required finance charges, such as origination fees and some mortgage costs. Because it folds in those charges, the APR is usually equal to or higher than the interest rate.
A worked example
Imagine a $20,000 loan at 7% for 60 months with a $600 origination fee taken out of the proceeds. Your payment is $396.02, but you only receive $19,400. If you solve for the rate that makes $396.02 a month repay $19,400 over 60 months, you get an APR of about 8.29%. A second lender offering 7.4% with no fee has a payment of $399.81 and an APR of 7.4%. The "7% loan" looks cheaper by rate, but costs more once the fee is counted.
How to compare offers
- Compare APR to APR and keep the term the same.
- Look at the total of payments, not just the monthly amount.
- Check whether fees are paid up front or rolled into the loan.
- Ask about prepayment penalties, which are not part of APR.
Limits of APR
APR assumes you keep the loan for its full term. If you repay early, an up-front fee is spread over fewer months, so the true cost can be higher than the APR suggests. APR also does not capture every cost, such as late fees, and for adjustable-rate loans it is based on assumptions about future rates.
Credit cards are different
Card APRs are usually quoted as a yearly rate but applied daily or monthly, and they often vary with a benchmark rate. Paying the full statement balance each month typically avoids interest on purchases, while carrying a balance triggers it.
Using calculators correctly
Most online calculators, including ours, ask for a single rate. If you enter the APR, the result will approximate the total cost including fees. If you enter only the interest rate, the result will leave fees out, so add them separately. In either case, the lender's Truth in Lending disclosure is the authoritative figure.
To see how a different rate changes your payment, try the loan calculator.
Mortgage APR and points
On mortgages, APR can include discount points, lender fees and mortgage insurance, so it is a handy way to compare loans with different fee structures. A loan with a lower rate but high points can have a higher APR than one with a slightly higher rate and no points. If you expect to sell or refinance within a few years, the break-even on points matters as much as the APR itself.
Key takeaway
Use the interest rate to understand your payment and the APR to understand the cost. Ask every lender for both numbers and the total of payments, in writing, before choosing.
Important
This guide is educational and not individualized financial advice. Loan terms vary by borrower, lender and market, so confirm details in the official disclosure.