Written by: Josh McFadden | Best Company Editorial Team
Last Updated: December 4th, 2019
Interest rate and annual percentage rate: two terms that often get tossed around when discussing loans and credit. Both are important to understand, and both are critical to the process of securing and paying off a loan.
Whether you're talking about financing your home, car, or recreational vehicle, or whether it's concerning credit cards, both of these terms play an important role in the loan/credit equation.
So what's the difference-or is there one at all?
While the interest rate is the amount a lender charges in addition to the principal that the borrower pays with the loan, the annual percentage rate, or APR, is much broader. Truly, it is an even more accurate measure of what the borrower will pay for the loan.
The APR is the amount, expressed in percentage form, that is the assigned interest rate for the given loan in addition to points, mortgage broker fees, and any other supplemental charges the borrower is required to pay to even secure the loan. When it comes to mortgage loans, the APR will include closing costs. Therefore, the APR is generally higher than the interest rate.
In easy-to-understand terms, the interest rate is a calculation of how much your monthly payment will be; the APR calculates the entire cost of the loan over its life. Further, if you as a borrower are most concerned with keeping your monthly costs low, you will pay close attention to and shop around for low-interest rates. But if you want the total cost of your loan to be lower, you will focus on the APR.
For many people, finding a low APR is important when buying a home because, over 30 years, they will pay less with a lower APR. At the same time, a lower interest rate means lower payments, but, if coupled with a high APR, the over-the-life-of-the-loan payment might be higher.
One caution prospective borrowers should take into account is that the APR does not take into account the maximum interest rate in adjustable-rate loans. Because of this, it's important for the borrower to look at factors other than just the APR when deciding what type of loan is best.
As with interest rates, the APR will fluctuate depending on the loan type and depending on market conditions and one's credit.
By way of comparison, here's a look at current U.S. averages in credit card APRs:
- Reward credit cards: 17.89% (source: valuepenguin.com)
- Business credit cards: 16.00% (source: valuepenguin.com)
As you are in the market for different types of loans and forms of credit, don't neglect the APR in your decision-making process.
Do you have another question? Find the answer with our FAQ page dedicated specifically to Personal Loans.