APR vs. interest rate, what is the difference?
Every loan offer shows two percentages, and they rarely match. The short version: the interest rate determines your monthly payment, and the APR helps you compare offers.
Interest rate: the price of the money
The interest rate is what the lender charges on the balance you owe. On a $300,000 mortgage at 6.5%, the first month’s interest is $300,000 × 6.5% ÷ 12 = $1,625. The rate does not include origination charges, points or other fees, so on its own it can make a loan look cheaper than it is.
APR: the rate with certain costs included
The annual percentage rate spreads certain upfront costs over the life of the loan and expresses the total as a yearly rate. US lenders must disclose it under the Truth in Lending Act, which makes it a useful common yardstick.
How fees change the APR
Take a $100,000 loan over 10 years at 6%. The monthly payment is $1,110.21.
| No fees | $3,000 in fees | |
|---|---|---|
| Interest rate | 6.00% | 6.00% |
| Monthly payment | $1,110.21 | $1,110.21 |
| Money you effectively receive | $100,000 | $97,000 |
| APR | 6.00% | About 6.68% |
The payment is identical. In the second case, though, you pay the same amount for the use of less money. The rate hides that, and the APR shows it.
Comparing two real-looking offers
Say you see two mortgage offers for the same amount and term:
- Offer A: 6.25% with $6,000 in points and fees.
- Offer B: 6.50% with $1,000 in fees.
A has the lower payment, and B costs less at closing. Which one wins depends on how long you keep the loan. Upfront fees are paid once, while a lower rate saves you money every month. If you are likely to sell or refinance in a few years, you may never earn back the extra cost of Offer A. If you stay for decades, you probably will.
To find your break-even point, divide the extra upfront cost by the monthly savings. If A costs $5,000 more upfront and saves $100 a month, it takes 50 months to break even. Use the loan calculator to get your actual payments.
What the APR leaves out
The APR is helpful, but it is not the full cost:
- It assumes you keep the loan for its full term. Fees spread over 30 years look small. If you leave after 5 years, your true yearly cost is higher than the APR suggests.
- It does not include every cost. The fees that count vary by loan type, and items such as some closing costs, property taxes and homeowners insurance may be excluded.
- On adjustable-rate loans, it rests on assumptions. The APR cannot know future rates, so it is not directly comparable with a fixed-rate APR. See fixed or adjustable.
- It says nothing about dollars. A long loan can have a low APR and still cost more in total interest than a shorter loan with a slightly higher APR.
APR is not APY
On savings, you will see APY, the annual percentage yield. APY includes compounding, so it shows what you actually earn in a year. On loans, a monthly rate of 6% ÷ 12 compounds to about 6.17% over a year, even though the rate and APR can both say 6.00%. So when you compare a loan and a savings account, you are not looking at exactly the same kind of number.
A checklist for comparing loans
- Match the amount and term. Otherwise, the comparison breaks down.
- Look at the rate and the APR together. A wide gap between them signals high fees.
- Ask for the total cost in dollars over the period you expect to keep the loan.
- Check for prepayment penalties, especially if you plan to pay extra.
- On mortgages, compare Loan Estimates. Lenders must provide this standard form, and it makes side-by-side comparison much easier.
One warning sign
Credit cards and some personal loans can carry APRs above 20%. At that rate, an unpaid balance doubles in under four years, as the rule of 72 shows. That is usually a reason to pay it off before investing.
The Consumer Financial Protection Bureau explains these terms in more detail.