Interest Rates vs Annual Percentage Rates: What's the Difference?
When lenders talk about the cost of borrowing, they often use terms like interest rates and annual percentage rates (APRs). But what’s the difference between the two?
Interest rates are the basic cost of borrowing money from a lender. It’s the percentage of the amount borrowed that the lender charges for the loan. The interest rate is usually expressed as an annual rate, but it can also be expressed as a monthly rate or a daily rate.
The annual percentage rate (APR) is the cost of borrowing money over the course of a year. It includes the interest rate plus any additional fees or costs associated with the loan. The APR is usually higher than the interest rate because it takes into account the additional fees.
For most loans, the interest rate and APR are the same. But for some loans, like mortgages, the APR can be higher than the interest rate because it includes additional fees like closing costs and points.
To understand the difference between interest rates and APRs, let’s look at an example. Let’s say you’re taking out a loan for $10,000 with an interest rate of 7%. The interest rate is the cost of borrowing the money, so you’ll owe $700 in interest over the course of the loan.
Now let’s say the loan also has a $500 origination fee. The APR takes into account the interest rate plus the origination fee. So the APR would be 7.5%, and you’d owe $750 in interest over the course of the loan.
The difference between the interest rate and the APR is important to understand when you’re shopping for a loan. The APR is a more accurate measure of the total cost of the loan, so it’s important to compare APRs when you’re looking at different loan options.
When you’re comparing loan options, it’s also important to consider other factors like the length of the loan, the repayment terms, and any prepayment penalties. All of these factors can affect the total cost of the loan, so it’s important to look at all of them when you’re deciding which loan is the best option for you.
Understanding the difference between interest rates and APRs can help you make better decisions when you’re shopping for a loan. Knowing the difference between the two can help you compare loan options and make sure you’re getting the best deal.