If you’re interested in the financial world or have any financial product, i.e., a credit card, you might have heard the terms “APR” and “interest rate” before. However, not everyone knows what they mean and the difference between the two.
In this article, we’ll take a look at both of those terms. When we’re finished, you’ll understand what they are, the difference between them, and why they matter.
What is the APR?
Looking at the difference between APR vs. interest rate is akin to looking at debt consolidation vs. credit card refinance offers—they’re related, but they’re not the same.
APR stands for the Annual Percentage Rate that a lending entity might quote you if they offer you a loan. The APR includes the interest rate the lender charges you for the loan, but it also includes all of the other costs associated with it.
Those costs might include discount points, closing costs, and fees. Like an interest rate that a lending entity might mention when you approach them and ask for a loan, they will express the APR as a percentage. In most cases, you can expect the APR to be higher or the same as the interest rate.
Factors that Influence APR
When applying for a loan it’s important to know what the fees will amount to. For instance, some entities will charge you an application fee when you apply for the loan, which becomes part of the APR.
You might also have to pay a “dealer prep” fee, a document fee, an underwriting fee, or a processing fee. All these fees become part of the APR. It’s similar to the various dealer fees you might have to consider as part of the final price when you buy a car.
What is the Interest Rate?
The interest rate is sometimes referred to by lending entities as the advertised or nominal interest rate. This is the percentage you will pay for a set period if you borrow money from the lender.
Like the APR, the lender will mention a loan’s interest rate as a percentage. This can be either variable or fixed. If you’re going ahead with the loan, you should know the difference. The interest rate can be set for any length of time, but lenders usually express it as an annual rate.
Fixed interest rates don't change, regardless of external factors, such as what financial markets do until you pay back the loan. A variable interest rate, though, can change during the time the loan is active. Variable interest rates are tied to index rates.
Understand APR vs. Interest Rate fact:
To summarize, a loan’s APR and interest rate are not dissimilar from each other, but they’re not the same thing, either. The loan interest rate, or advertised rate, is the number a lending entity will give you before they calculate additional fees they add on if you agree to accept the loan.
The Annual Percentage Rate is the loan’s interest rate that the lender is charging you, but it will also include various fees, closing costs, discount points, etc.
Because the APR is the annual interest rate plus things like document fees, dealer prep fees, processing fees, etc., it makes sense that the APR will be higher than the interest rate in almost all instances. In both cases, though, the lender will express these numbers to you as annual rates.
If you plan to go ahead with a loan offer, make sure you ask the lender what the APR is, as well as the interest rate. The APR’s final number will reflect the annual rate you’ll have to pay rather than the advertised one. You should also understand whether you’re getting a fixed rate or variable interest rate on your loan since fixed-rate loans are stable while variable ones are more volatile.