It’s not uncommon for those outside the world of banking and finance to use the terms interest rate and APR interchangeable. But there is a significant difference between interest rate and APR, and knowing that difference can help you choose a personal loan that could save you thousands of dollars.
Everything Interest Rate Related
Interest rates are, for the most part, straightforward. When talking about personal loans, interest rates are the cost of borrowing the loan principal from the start to finish of the loan, expressed as a percentage. This is the amount you’ll pay yearly for borrowing that amount.
When dealing with fixed vs. variable rate loans, interest rates can become more complicated. Personal loans, like those offered by Discover Personal Loans, have a fixed interest rate, making future payments easier to plan.
All About Annual Percentage Rate (APR)
When addressing the annual percentage rate vs. interest rate question, it’s not uncommon for borrowers to wonder why there’s a need for both percentages. Once we understand that interest rate is the initial cost of borrowing a set amount of money—the principal of the loan—it’s easy to become even more confused about APR.
Put in very basic terms, APR is a more comprehensive measure of what you’ll pay back over the life of the loan, and takes into account each of the following:
- Your interest rate: the amount of money you owe for borrowing the loan principal.
- Any associated fees: loan origination fees and closing costs are common charges; Discover Personal Loans doesn’t charge borrowers loan origination fees—or any fees, for that matter as long as you make your monthly payments on time.
- Other finance charges: these might include pre-payment charges and other less common fees.
The difference between interest rate and APR on a personal loan is just that simple: Annual percentage rate (APR) is your base interest rate plus any additional charges for securing the personal loan.
How Is Personal Loan APR Calculated
Your personal loan APR is calculated with your amount borrowed, the length of your loan, and any fees that are charged (at origination and/or ongoing). Two loans for the same amount and the same term length, but with different origination fees and interest rates, will have different APRs. All things being equal—the same term length and loan amount—you’ll likely want to choose the loan with the lower APR.
There are lots of factors that determine a borrowers approved APR:
- Credit score
- Loan amount
- Loan term
There are a wide range of APRs to be found for personal loans. What’s deemed a “good” or “bad” APR is subjective, and can depend on what you can and cannot afford, what you do and do not feel comfortable with, and what you value in a lender and a personal loan that may or may not outweigh the APR you receive.
How Should You Choose Your Loan?
When shopping for a personal loan—or any loan—compare apples-to-apples numbers. It may be helpful to view annual percentage rate vs. interest rate as total cost of borrowing vs. the base cost of securing your personal loan. Frankly, it may not be useful to compare interest rates to APRs, though there are tools and formulas available for this. Ideally, your loan servicer will be able to answer any questions you have about these rates—and they should really be promoting APR clearly any time interest rates appear, so you fully understand the total cost of borrowing
Additionally, take both rates into account when comparing loans among lenders and even similar loans from one financial institution. What looks like a few points in either direction can mean big savings—or overspending—over the life of your loan.