APR is NOT the Same as Interest
When you borrow money, the lender charges you for the use of that money.
Two numbers you will commonly see when looking at a loan are the interest rate and the APR.
They are connected, but they are not the same thing. Understanding the difference can help you compare loans and credit offers more accurately.
What Is an Interest Rate?
The interest rate is the percentage a lender charges you for borrowing money.
For example, imagine you borrow $10,000 with a 6% interest rate. That 6% is used to calculate the interest you owe on the loan.
The interest rate focuses on the cost of the money you borrowed.
Your actual interest charges will depend on the loan balance, payment schedule, and how long you take to repay the loan. As you make payments and your balance decreases, the amount of interest charged can also change.
When comparing loans, a lower interest rate generally means less interest charged, assuming the other loan terms are the same. We explored this earlier in our What is Interest article.
What Is APR?
APR stands for Annual Percentage Rate. It gives you a broader measure of the cost of borrowing by taking the interest rate and certain additional loan costs into account.
This is where APR can be confusing because interest is expressed as a percentage, while fees are usually listed as dollar amounts.
For example, imagine two lenders offer you the same $10,000 loan for five years:
Lender A | Lender B | |
Interest rate | 6% | 6.25% |
Upfront fee | $500 | $0 |
Loan term | 5 years | 5 years |
At first, Lender A appears cheaper because its interest rate is 6% compared with Lender B's 6.25%.
However, Lender A also charges a $500 fee.
That fee is part of what you are paying to obtain the loan. When the APR is calculated, certain fees like this are incorporated into the calculation and expressed as part of an annualized percentage.
The $500 does not simply get added to the 6% interest rate. Instead, the APR calculation considers the fee along with the interest rate, loan amount, and repayment period.
As a result, Lender A's APR will be higher than its 6% interest rate.
Lender B has a higher interest rate but no upfront fee, so its APR may be closer to its 6.25% interest rate.
This gives you two different ways of looking at the cost:
What it tells you | |
Interest rate | The rate used to calculate the interest charged on the money you borrow |
APR | A broader annualized measure that incorporates the interest rate and certain additional borrowing costs |
Why Is APR Useful?
APR can be especially helpful when comparing loans that have different interest rates and fees.
Consider two offers with the same loan amount and repayment period:
Loan A: 6% interest rate + $500 in fees
Loan B: 6.25% interest rate + $0 in fees
Looking only at the interest rate makes Loan A look cheaper. Looking at the APR gives you another way to account for the $500 fee when comparing the two offers.
The difference between the interest rate and APR can become more noticeable when a loan has significant upfront costs.
The length of the loan also matters.
A $500 fee has a different annualized effect on a loan that lasts two years than it does on a loan that lasts 20 years.
This is one reason the APR calculation considers the loan term rather than simply adding the fee to the interest rate.
What Should You Look at When Comparing Loans?
APR can make comparing loan offers easier, but it should not be the only number you consider.
Look at:
Interest rate: The rate used to calculate the interest charged on the loan.
APR: A broader measure that incorporates the interest rate and certain additional borrowing costs.
Loan amount: How much you are borrowing.
Loan term: How long you have to repay the loan.
Monthly payment: How much you will be expected to pay each month.
Total amount repaid: How much you will pay over the life of the loan.
Fees: The specific charges associated with getting or maintaining the loan.
When you understand both the interest rate and APR, you can look beyond the lowest advertised percentage and see more of the costs involved in borrowing the money.
Final Thought
Interest rates and APR are both important when you borrow money.
The interest rate is the cost you owe in addition to the original payment.
APR is the original rate, plus the cost of additional fees from the lender.
Looking at both, along with the loan term, monthly payment, and total amount you will repay, gives you a clearer picture of what you are agreeing to pay.
Up Next: Now that you understand interest rates and APR, we'll move into specific types of borrowing. Next, we'll look at personal loans, how they work, when they may be useful, and what to consider before taking one out.
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