Interest Rate vs. APR: What's the Real Difference?

What Is an Interest Rate?

The interest rate is the cost you will pay each year to borrow the money, expressed as a percentage rate. It does not reflect fees or other charges. In simple terms, it's the basic price a lender charges for lending you money.

The interest rate is the number most often used to calculate your monthly payment, but it only tells part of the story. It ignores upfront fees, closing costs, and other expenses that can add to the total cost of your loan.

• Annual cost of borrowing expressed as a percentage of the principal.
• Does not include fees, points, or other charges.
• Used in the calculation of your monthly payment.

Sources: Consumer Financial Protection Bureau, Calculator.net

What Is APR (Annual Percentage Rate)?

The annual percentage rate (APR) is a broader measure of the cost of borrowing that reflects the interest rate plus any points, mortgage broker fees, and other charges. It gives you a more complete picture of what a loan actually costs over its term.

Because APR includes many fees, it is usually higher than the interest rate. This is why comparing APRs is a more accurate way to compare loan offers: a loan with a lower interest rate but high fees could end up with a higher APR than a loan with a slightly higher rate but few fees.

• Broader measure of borrowing cost than the interest rate.
• Includes qualifying fees and charges, such as origination fees and points.
• Usually higher than the interest rate.
• Useful for comparing overall loan costs across lenders.

Sources: Consumer Financial Protection Bureau, Bankrate, Calculator.net

How APR Is Calculated

APR is calculated using a formula that incorporates the interest rate, certain fees, and the loan term. A common simplification of the formula is:

APR = ((Interest + Fees) / Loan Amount) / Number of Days in Loan Term × 365 × 100

This formula treats the loan as a simple interest loan and does not account for the compounding of interest or the exact amortization schedule. Actual APR calculations for amortized loans can be more complex and may vary by lender. The Truth in Lending Act (TILA) requires lenders to disclose the APR to consumers before finalizing a loan, so you have a standardized number to review.

Sources: Consumer Financial Protection Bureau, TransUnion, Experian, Discover

Example: $10,000 Loan with 5% Interest and $300 Origination Fee

This example is simplified and may not match the exact APR a lender would quote, but it illustrates how even a modest fee can raise the APR above the interest rate.

Sources: TransUnion

Interest Rate vs. APR: Comparison Table

The table below summarizes the key differences between the interest rate and APR.

Sources: Consumer Financial Protection Bureau, Calculator.net

Why APR Matters When Comparing Loans

When comparing loan offers, the APR is a more reliable indicator of the total cost than the interest rate alone. Because APR incorporates many fees, it allows you to compare loans on a like-for-like basis.

The Consumer Financial Protection Bureau advises borrowers to compare APRs to APRs, and not to interest rates, when evaluating loans. This is because the two numbers measure different things, and comparing a loan's APR to another loan's interest rate would be misleading.

Keep in mind that the APR may not include every fee, such as late payment fees, property taxes, insurance, or third-party services. Be sure to read the loan documents to understand which fees are included in the APR and which are not.

• APR provides a more complete picture of borrowing costs than interest rate alone.
• Use APR when comparing loans from different lenders.
• Review the loan estimate to see which fees are included in the APR.

Sources: Consumer Financial Protection Bureau, TransUnion