APR vs Interest Rate
When shopping for loans or mortgages, you'll see both an interest rate and an APR (Annual Percentage Rate). While they sound similar, they represent different things and can significantly affect what you actually pay.
Interest Rate
The interest rate is the cost of borrowing the principal amount. It does not include fees, closing costs, or other charges associated with the loan.
- •Only includes the cost of borrowing principal
- •Does not include fees or closing costs
- •Always lower than or equal to APR
- •Determines your monthly payment amount
APR (Annual Percentage Rate)
APR includes the interest rate plus all additional fees and costs spread over the life of the loan. It represents the true annual cost of borrowing.
- •Includes interest rate + fees + closing costs
- •Represents the true cost of borrowing
- •Always equal to or higher than interest rate
- •Required by law (Truth in Lending Act)
Key Differences
| Aspect | Interest Rate | APR (Annual Percentage Rate) |
|---|---|---|
| What's Included | Interest only | Interest + fees + costs |
| Typical Value | Lower number | Higher number |
| Best For | Monthly payment calculation | Comparing loan offers |
| Required by Law | No | Yes (TILA) |
| Example: 6.5% rate, $3k fees | 6.5% | ~6.7% |
When to Use Each
Use the interest rate to understand your monthly payment. Use APR to compare total costs between different loan offers. The loan with the lower APR usually costs less overall.
Frequently Asked Questions
Why is APR higher than the interest rate?
APR includes additional costs like origination fees, closing costs, mortgage insurance, and discount points. These costs are spread over the loan term, making the effective annual rate higher.
Should I choose the loan with the lowest APR?
Usually yes, but consider your situation. If you plan to sell or refinance within a few years, a loan with lower upfront fees but slightly higher rate might cost less overall.