When you apply for a loan or a credit card, the lender will present you with an interest rate and an Annual Percentage Rate (APR). While they sound similar, understanding the difference is crucial to determining the true cost of borrowing money.
Interest Rate vs. APR: What's the Difference?
The interest rate is the basic cost of borrowing the principal loan amount. It does not include any additional fees.
The APR (Annual Percentage Rate), on the other hand, is a broader measure. It includes the interest rate plus any additional fees or costs associated with the loan, such as origination fees, closing costs, or administrative fees. APR represents the true annual cost of the loan expressed as a percentage.
Why APR Matters More
Because the APR includes fees, it gives you a much more accurate picture of how much you'll actually pay. For example, a loan with a 5% interest rate and high fees might have an APR of 7%, making it more expensive than a loan with a 6% interest rate and no fees (an APR of 6%).
Always use the APR, not the interest rate, when comparing loan offers from different lenders.
Types of APR
- Fixed APR: The rate remains the same throughout the life of the loan. This offers predictable monthly payments and is common with personal loans and auto loans.
- Variable APR: The rate fluctuates based on an underlying index (like the prime rate). This means your payments can go up or down over time. Credit cards typically have variable APRs.
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See My Personalized Offers →How to Lower Your APR
Your APR is largely determined by your credit score and financial health. To secure lower rates in the future:
- Improve your credit score: Pay all bills on time and keep credit card balances low.
- Apply with a co-signer: A creditworthy co-signer can help you qualify for better rates.
- Opt for a shorter loan term: Lenders often offer lower APRs for shorter repayment periods, though this means higher monthly payments.
