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Getting a loan typically means paying interest―it's the cost of borrowing money. And shopping for the least expensive loan or credit card option involves comparing the cost to borrow among various lenders. But if you simply look at the interest rate, are you truly making an accurate comparison? Not necessarily.
While you may sometimes see them used interchangeably, the key difference between an interest rate and annual percentage rate (APR) is that APR represents not only the debt product's interest rate, but also any additional fees and other costs associated with it. That makes APR the more revealing number to look at when you need an apples-to-apples comparison of two offers. The only exception is credit cards: With these, interest rate and APR are the same thing. Here's what you need to know.
What Is Interest?
An interest rate is the cost a borrower pays to borrow money. You'll usually see it expressed as a percentage of the amount borrowed.
Whatever type of loan you're getting—whether it's an installment loan such as a mortgage, auto loan, student loan or personal loan, or revolving credit such as a credit card, you'll typically pay interest on your balance until it's fully repaid.
How Are Interest Charges Calculated?
Interest charges are calculated as a percentage of your loan amount. For example, if you borrowed $30,000 to buy a car at an interest rate of 5% over 60 months, you would pay a total of $3,968 over the life of the loan.
Calculating interest on a credit card can be a little more complicated. Credit card interest is charged based on your average daily balance and the daily interest rate, which is your card's annual rate divided by 365 (the number of days in a year). To make this easier, you can use a credit card payoff calculator to figure out your interest charges.
What Is APR?
An annual percentage rate, or APR, is the true cost to borrow money with an installment loan such as a mortgage, student loan, auto loan or personal loan. APR factors in a loan's interest rate plus any other charges, such as:
Because APR includes fees and interest bundled into one number, it can help you better understand the total cost to take out a loan. It's the rate to look at when comparing rates between loans to find the cheaper option.
How Is APR Calculated?
Just like with interest, APR is represented in the form of a percentage of the amount borrowed. Unlike interest, however, calculating a loan's APR takes into account all other costs associated with the loan.
For an installment loan, APR is calculated by adding all fees associated with the loan to the interest. For example, a $10,000 personal loan with an interest rate of 13% and an origination fee of $400 repaid over a term of three years has an APR of 15.77%.
For credit cards and other types of revolving credit such as home equity lines of credit (HELOCs), APR is the same as the loan's interest rate and doesn't include fees. In these cases, the terms APR and interest rate are interchangeable and either can be used to compare multiple credit cards.
†The information provided is for educational purposes only and should not be construed as financial advice. Experian cannot guarantee the accuracy of the results provided. Your lender may charge other fees which have not been factored in this calculation. These results, based on the information provided by you, represent an estimate and you should consult your own financial advisor regarding your particular needs.
What's the Difference Between Interest and APR?
While both the interest rate and APR reflect the cost to borrow, APR gives you more direct information about what you're paying—except in the case of credit cards.
Generally speaking, the two biggest factors that dictate what you'll repay when you take out a loan are the principal borrowed and the interest rate that applies to the loan. In reality, however, you'll also want to consider costs such as origination fees and other lending fees since they also impact what you will ultimately repay. Instead of looking at interest alone, APR helps you see all these costs at a glance.
This makes APR a more accurate way to understand a loan or to compare two loans. For example, if two loans have the same interest rate but different APRs, the loan with the lower APR will often be the better deal.
|APR vs. Interest Rate|
|The total cost to borrow money as a yearly percentage of the loan amount||The rate you pay a lender to borrow money as a percentage of the loan amount|
|Includes interest and all lender or broker fees, such as an origination fee||Doesn't include fees|
|Can give you a more complete look at how much you'll really pay to borrow||While a lower interest rate typically means a more affordable loan, look at APR for an apples-to-apples comparison when loan shopping|
Why Is APR Higher Than Interest?
APR will generally be higher than interest because APR takes into account not just a loan's interest rate, but any fees associated with the loan. In some cases, such as when a loan has no fees, APR may be equal to the interest rate.
The Bottom Line
Knowing the difference between interest and APR can help you evaluate the best loan for you. What lenders will charge you to borrow in large part comes down to your credit report and score. Before you explore loan options, check your credit score for an idea of where your score falls now.
You can also sign up for free credit monitoring through Experian to receive regular updates and pinpoint areas where you may be able to improve your credit. Taking these steps now can help you save money when you're ready to borrow.