Simply put, the interest rate is the amount a lender charges you to borrow money. The annual percentage rate, or APR, is the effective rate after all loan expenses are added.
While the terms APR and interest rate are often used interchangeably, understanding each can help you make smart decisions when considering whether a personal loan, mortgage, or other loan fits into your budget.
Knowing the difference between APR and interest rate can better prepare you to compare lenders and choose the best loan to help you reach your financial goals. We’ve outlined it below to help you on your personal finance path.
If you’re interested in seeing how an APR can affect your monthly payments, you can use our personal loan calculator.
Interest rate is the percentage you pay to borrow the principal amount of your loan, typically stated as an annual rate. The interest rate applies to the life of the loan—from the day it’s borrowed to the day it’s paid off.
Interest rates come in two varieties: fixed or variable. As the name suggests, a fixed interest rate stays the same throughout the life of the loan. With a fixed-rate loan you can budget more easily, as you always know how much you owe each month.
Variable interest rates can change over time. They are tied to a benchmark rate, like the prime rate. The prime rate can change periodically, depending on decisions by the Federal Reserve. Because of this, a variable-rate loan comes with some uncertainty about how much you will owe on your loan the future.
APR is the total cost of the loan expressed as a percentage. In addition to the interest rate, the APR includes other borrowing costs like lender fees.
The APR and interest rate may be the same for loans that don’t charge fees.
By comparison, when a loan also has origination fees or closing costs, the APR will be higher. The Truth in Lending Act (TILA) requires lenders to explain both the interest rate and APR you will pay for your mortgage or loan. Look for this information on the Loan Estimate and in the Closing Disclosure.
With a Discover® personal loan, for example, there are no fees at all. That means your interest rate is also your APR.
Your APR affects the total loan cost. Many borrowers look for the lowest interest rate when they research loan options. But that focus may not give you a full picture of the cost. A loan with a lower interest rate may not always be the cheapest option if there are other fees. That’s why APR is essential to making informed financial decisions.
The stated interest rate only calculates the cost of borrowing the principal. The APR is a better reflection of the total lifetime cost of the loan. It includes the interest rate plus other expenses and fees. These fees can add up, so you might owe more over the life of your loan, even if the interest rate is low.
For example, let’s say you wanted to take out an $18,000 loan to be repaid over 60 months. If the loan has a 12.99% interest rate and does not charge any origination fees, the APR would also be 12.99%.
If the loan instead has a 12.99% interest rate but charges fees of 5% of the loan amount, those extra fees would bring the APR to 15.18%.
Here is a quick comparison of how a loan origination fee affects the APR when the loan amounts and interest rates are the same. In this scenario, the loan with no origination fee saves the borrower around $900 over the life of the loan.
|
No fee |
5% origination fee |
|---|---|---|
Loan amount |
$18,000 |
$18,000 |
Interest rate |
12.99% |
12.99% |
Payment term |
60 months |
60 months |
Total principal |
$18,000 |
$18,000 |
Origination fee |
0% |
5% |
Total borrowing cost |
$6,567.79 |
$7,467.79 |
APR |
12.99% |
15.18% |
Lender fees can significantly increase the APR of a loan.
In other words, looking at the APR reveals the true borrowing cost. When you compare APR across loan options, you can see which loan would cost you more over time. This way, you can see how it may fit into your budget and where you can potentially save money on your loan.
Many factors are used to determine your interest rate, such as your credit history, application information, and the repayment term you select. Loans with longer repayment terms often have lower interest rates, though you could potentially pay more in total interest by the time the loan is repaid.
Lenders see credit scores as an indication of creditworthiness. The higher your score, the more likely you are to pay back your debts. You might be able to lower your interest rate by boosting your credit health—though it will take time. Here are some steps you can take:
If you are considering a Discover personal loan, here is one way we show that we value our customers: The majority of Discover cardmembers receive a lower interest rate on a personal loan than non-cardmembers.
Here are factors that affect:
The APR is not always higher than the interest rate. They can even be the same number. If you are considering a personal loan with an APR much higher than the interest rate, the answer lies in the various lender fees that may be included with the loan. These fees are added to the interest rate to arrive at the APR.
Comparison shopping can help you understand the typical costs for a given loan amount. Be sure to find out what fees and charges are being added to the interest rate to arrive at the total APR and compare these among lenders.
A good APR is a combination of interest rate and fees that is below the market average. This may depend on your credit score and the lender.
If you have a strong credit history of repaying your loans, you may receive a lower interest rate. An excellent or good credit score may receive a lower rate than a score of fair or poor. A 12.99% interest rate would be considered good if the market average was 16.99%. Discover Personal Loans offers a tool that compares our APR range with several competitors.
A good APR will also be affected by any additional fees. By comparing lenders you can find the best APR for you.
Comparing APRs between loans can help you make an informed decision. As with any financial choice, make sure to get all the facts. Remember: APR is the total cost of borrowing, and it includes up-front fees and other charges. It’s a better, more complete picture of how much a loan costs than the interest rate alone.
So, always consider both interest rates and APR when you compare lenders. Because Discover Personal Loans charges no fees of any kind, your interest rate and APR are always the same.
When comparing APR vs. interest rate while shopping for a loan, it can be easy to confuse the two. But there are important differences.
While interest rates are part of understanding how much a mortgage or loan will cost, they don’t tell you everything. APR gives you a fuller picture of the total cost of a loan. With this information, you’re in a better position to find a loan you can afford and choose the terms that will fit within your budget.
Articles may contain information from third parties. The inclusion of such information does not imply an affiliation with the bank or bank sponsorship, endorsement, or verification regarding the third party or information.
