APR vs. Interest Rate: What’s the Difference?
Every loan offer shows two percentages: an interest rate and an APR. They look similar, but they answer different questions, and mixing them up can lead you to pick the more expensive loan.
What the interest rate is
The interest rate is the yearly cost of borrowing the principal, expressed as a percentage. It is the number used to calculate your monthly payment. It does not include any fees.
What APR is
The annual percentage rate (APR) is the yearly cost of the loan including the interest rate and most upfront lender charges, such as:
- Origination fees
- Discount points on a mortgage
- Certain closing costs and mortgage broker fees
Because it folds in fees, the APR is almost always higher than the interest rate. Under the federal Truth in Lending Act, lenders must disclose the APR so borrowers can compare offers on equal terms.
An example
Two offers for a $10,000 personal loan over 5 years:
| Offer | Interest rate | Origination fee | Monthly payment | APR (approx.) |
|---|---|---|---|---|
| A | 8.0% | 5% ($500) | $203 | 10.2% |
| B | 9.0% | None | $208 | 9.0% |
Offer A has the lower rate and the lower payment, but because the $500 fee is taken out of the money you receive, it is the more expensive loan.
Which number to use
- To compare loans from different lenders: APR, as long as the loan amount and term are the same.
- To know your monthly payment: the interest rate.
- For credit cards: the APR and the interest rate are effectively the same thing, since card APRs do not include annual fees.
Where APR falls short
It assumes you keep the loan for the full term. On a mortgage, upfront fees are spread over 15 or 30 years in the APR calculation. If you sell or refinance after five years, a loan with a lower rate and higher fees can cost more than its APR suggested.
Not every cost is included. Items such as appraisal fees, title insurance or homeowners insurance are typically left out, and lenders differ slightly in what they include.
Adjustable-rate loans are estimates. The APR on an ARM is based on the index value when the loan is made, not on where rates will be later.
APR is not APY
APY (annual percentage yield) is used for savings accounts and CDs. It includes the effect of compounding, so it shows what you actually earn in a year. APR does not include compounding. That is why a credit card with a 24% APR that compounds daily costs closer to 27% a year if you carry a balance.
Fixed vs. variable APR
A fixed APR stays the same for the life of the loan. A variable APR moves with a benchmark such as the prime rate, so your payment can go up or down.
What to do before you sign
- Get quotes for the same loan amount and term from at least three lenders.
- Compare APRs first, then total fees.
- Ask for the total amount you will repay over the life of the loan.
- For a mortgage, compare the Loan Estimate forms line by line.
Results are estimates for informational purposes only and are not financial, tax, legal or medical advice.