Understanding the Difference between Interest Rate and APR

Do you know the difference between an APR and an interest rate?

For many consumers, it’s a confusing topic. Even so, understanding the difference between an interest rate and an annual percentage rate, or APR, could save you a tremendous amount of money on your next loan.

Interest Rate

An interest rate refers to the amount of money it costs to borrow the principal amount of a loan.

Interest rates may be fixed or varied, but they are always expressed as percentages.

APR = Annual Percentage Rate

An annual percentage rate, or APR, is much broader in nature.

It includes both the interest rate as well as other expenses, such as discount points, broker fees, and closing costs.

Like an interest rate, an annual percentage rate is expressed as a percentage.

Why Do You Need Both?

The primary difference between interest rate and APR is that the interest rate determines the amount of your monthly payment. By comparison, the APR shows you the total cost of your loan. When shopping for loans, you may use one or both to compare loan options.

For instance, the loan with a lower interest rate will naturally have a lower payment, assuming both have a fixed interest rate for the same term. A lower APR would grant you a lower total cost for a loan.

The key when making comparisons is to understand what is most important to you. For instance, if you are primarily concerned with obtaining the lowest monthly payment, then the interest rate will be of the most concern to you. Likewise, if you’re looking for the lowest total cost for a loan, you should compare APRs.

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