APR vs Interest Rate: 5 Important Money Borrowing Things to Know

When you’re applying for a loan, it can be challenging to keep track of all of the details, interest rates, and offers lenders advertise. For consumers, making an educated lending decision starts with understanding how lending rates work, and knowing what numbers they should focus on when making a financial commitment.

In this post, we’re discussing the difference between APR and interest rates, and providing consumers with five money borrowing tips to know before signing any loan agreement.

Looking for information on a specific topic? Use the links below to navigate to each topic.

• What’s The Difference Between APR and Interest Rate?
  • APR
  • Interest Rate
• Not All Lending Is Created Equal
• Weigh Your Options
• Know Your Rights as a Lending Applicant
• Apply For a Loan That Makes Sense For You
• Good Credit Pays Off

What’s The Difference Between APR and Interest Rate?

Despite United States mortgage balances reaching $9.1 trillion in 2018, and other non-housing loan balances consistently on the rise, many consumers remain unclear on how APR and interest rates really work in regard to lending.

Truth be told, these mysterious numbers can often complicate the lending process and leave consumers in the dark when it comes to choosing the best lending option for them. We’re here to clear up the differences to help you make more informed lending decisions.

APR and interest rates do share some similarities. Both numbers are expressed as percentages and are used by lenders to indicate the rate a borrower will agree to pay in addition to their loan amount when borrowing money from a lender.

However, they do have a few key differences. Let’s explore below:

APR

APR, or Annual Percentage Rate, is a broad perspective of the amount consumers can expect to pay when borrowing money. The FTC glossary says APR includes: interest rate, points, mortgage insurance, broker fees, and miscellaneous credit charges that the borrower may be required to pay. This number is used to give borrowers more information about what they’re actually paying for their loan.

APR is measured on a yearly basis and is expressed as a yearly rate.

How Is APR Calculated?

While APR is generally presented as an annual rate, consumers can figure their APR on a monthly, and even daily basis. American Financial Solutions uses the following example to calculate an APR of 18%.

Calculate Monthly Periodic Rate on a yearly APR of 18%:

APR (18%) ÷ Months in the Year (12) = 1.5%

Calculate the Monthly Interest Rate using a Monthly Periodic Rate:

Average Daily Balance ($100) x Monthly Periodic Rate (1.5) = Monthly Interest Rate ($1.50)

Calculate the Daily Periodic Rate:

APR (18) ÷ Days in the Year (365) = Daily Periodic Rate (.05)

Interest Rate

The interest rate is the percentage of the loan amount that the borrower will be responsible for paying in addition to their initial loan amount. Unlike APR, this number does not include any additional fees that the borrower may be responsible for. Interest rate is a smaller picture of what you can expect to owe on your loan monthly, whereas APR is a big picture of what you owe for the lifetime of your loan.

Since interest rates don’t include as many costs as APR, interest rates are typically a lower percentage.

Interest rates are most often calculated into the borrower’s monthly payments and apply to practically any type of loan whether it’s a credit card or mortgage loan.

Not All Lending Is Created Equal

APR and interest rates are not always reflected the same depending on the kind of loan you’re talking about. When it comes to credit cards, APR and interest rates are used interchangeably and actually refer to the same amount of added interest. This means that the credit card owner is responsible for their spending plus the amount of interest charged by their credit card company— there are generally not any of the additional fees that are included in APR.

For mortgages, auto loans, and other non-credit card loan types, APR and interest rates are defined as two different numbers that both contribute to a borrower’s total amount owed. These kinds of loans typically have more associated fees to pay in addition to the cost of the loan.

Weigh Your Options

When shopping for any kind of loan, it’s important to consider all of your options.

When you’re comparing loan options, your lender should provide you with the APR and interest rate to show you how much you’ll actually be paying for your loan. Which of these numbers matters more? While both are important, the FTC recommends paying close attention to additional fees included in your APR that may have a larger impact on how much you owe on your loan.

Some lenders will advertise a lower interest rate, but make up for this low interest with associated fees that are included in the APR—so considering both of these numbers will be helpful in making a loan decision. For example, a lender may offer a 2% interest rate, while the APR is 20%, meaning the borrower actually ends up paying more for their loan than if the interest rate was higher, with lower APR fees.

It’s important to note that APR and interest rates aren’t the only numbers consumers will want to consider when agreeing to a loan. If the loan is an adjustable-rate mortgage, the borrower will want to consider the maximum rate, for example. If there are any conditions like a lock-in interest rate, the borrower may also want to know if there is a fee to lock-in, and how long the locked-in rate will last. To help you consider your mortgage options, the FTC has a developed a mortgage worksheet for an at-a-glance way to compare lending offers.

Know Your Rights as a Lending Applicant

Before signing on to a loan agreement, consumers should be aware of their borrower’s rights so that they can make the best loan decision for them.

Consumers are protected under the following regulations, designed to prevent lenders from denying an applicant a loan or offering less-favorable loan terms within these parameters.

• The FTC requires lenders to abide by the Equal Credit Opportunity Act which prohibits lenders from discriminating against lender applicants during any point in their credit transaction on the basis of race, color, religion, sex, national origin, age, marital status, if an applicant’s income comes from a public assistance program, or whether the applicant has exercised a right under the Consumer Credit Protection Act.
• The FTC requires lenders to also follow the Fair Housing Act which prohibits discrimination on the basis of race, color, religion, sex, handicap, familial status, or national origin pertaining to real estate transactions.

Apply For a Loan That Makes Sense For You

When you’re applying for loans, it’s important to consider what kind of loan makes the most sense for you. There are many different lenders out there and different kinds of loan options available to consumers. Depending on what you can afford, your credit score, and the kind of loan that suits your financial plan—consumers should consider what kind of loan best fits into their budget and lifestyle.

Applying for a mortgage? Lenders often offer two options when it comes to interest rates—an adjustable-rate mortgage (ARM) and a fixed-rate mortgage. Depending on how you plan to budget, and your long term financial plan, one may benefit you more than the other. Doing your research on prospective lenders and loan estimates is key to securing a loan that works for you.

Another thing consumers may want to be cognizant of when applying for new loans or lines of credit is their existing credit score. Credit scores are often a significant piece of the loan approval process as it gives lenders insight into a consumer’s past loans and financial behavior.

Lenders generally run a “hard credit inquiry” on applicants, which can dock a few points from their score. To avoid running unnecessary credit checks, consider checking how your score stacks up to the lender’s loan approval requirements before applying.

Good Credit Pays Off

Maintaining a good credit score can translate to many benefits for consumers, including optimal lending options. While it’s not the only thing lenders will consider when proposing an interest rate or APR, having a good credit score can certainly help.

Running a free credit score check regularly can help you stay on top of falling credit, and give you an idea of where adjustments in your credit behavior should be made. Besides giving you an edge with lenders, maintaining a good credit score can help consumers adjust their credit limit and be approved for property rental.

Now that you know how the differences between APR and interest rate, you can compare your lending options with a more discriminating eye and make a financial decision that makes the most sense for you.