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Getting a loan means paying interest—it's the cost of borrowing money. Just how much interest you'll pay depends on your interest rate. Or does it depend on your APR (annual percentage rate)?
The two terms are often used interchangeably, but sometimes there is a difference. When it comes to mortgages, car loans, and other types of installment loans, the difference between APR and interest rates is important. But when you're evaluating a credit card offer, there's actually no difference at all.
What Do APR and Interest Rate Mean?
APR might stand for Annual Percentage Rate, but in practice, it includes both the installment loan's interest rate plus other charges such as points and fees.
An installment loan is one with a predefined number of payments which are to be paid according to a fixed schedule. Examples of installment loans include home mortgages, student loans, car loans and personal loans.
You can also borrow money with a revolving loan, such as a credit card, a home equity line of credit or a business line of credit. With a revolving loan, you'll only see an APR, which will be the same as the loan's interest rate.
Your credit card may in fact have associated fees—such as annual fees or late payment fees—but credit card issuers don't include these in the APR, unlike installment loans.
How Do APR and Interest Rates Work for Installment Loans?
The term APR is meant to reflect the total cost to you of borrowing money, in the form of a percentage rate. These costs include loan origination, mortgage insurance and other fees, plus any "points" you may have to pay upfront in order to receive a lower interest rate.
By comparing the loan's APR to its interest rate, you can learn how much of your costs will be interest charges, and how much will be other fees.
For example, when you receive a loan estimate from a mortgage lender, the interest rate will be listed on the first page, under "Loan Terms," while the APR will be found on page three under "Comparisons."
Since car loans and other types of installment loans are not as highly regulated, you'll find this information in different places. For a car loan, the costs that are included in an APR and are often called prepaid financing charges.
How Do APR and Interest Rates Work for Credit Cards?
A credit card is a revolving line of credit, and there is no difference between a card's interest rate and its APR. These two terms are used interchangeably, but when you look up a credit card's terms, you'll see it expressed as an APR.
Every credit card issuer is required by law to display its cards terms and conditions in a standardized format, that's often called a "Schumer Box," after New York Senator Charles Schumer who is credited with enacting this requirement.
The Schumer Box essentially bypasses the nearly unreadable small print that card issuers use to document their terms, and mandates a standard size font and format that all card issuers must use to communicate the car's core terms. Here you'll notice that your credit card likely won't have a single interest rate, but several.
There's often a standard interest for purchases, one for balance transfers, and a separate one cash advances. Most cards also have a higher penalty interest rate for when you've made late payments. Furthermore, many cards will list several possible interest rates, or a range of rates. The rate you receive will be based on your creditworthiness when you applied for the card.
Finally, nearly all credit cards now offer variable interest rates. These are rates that can change with the Prime Rate. The Prime Rate is the lowest interbank interest rate which banks can borrow money at commercially, and its the basis for most credit card interest rates. Your credit card's interest rate will be equal to the Prime Rate, plus a fixed amount.
However, the Prime Rate is determined by the federal funds rate, which is set by the Federal Reserve's Open Market Committee. From December of 2008 to December of 2015, the Prime Rate held steady at 3.25%. Yet since then, it has been raised by a quarter of a point several times, including three times in 2017. Whenever the Prime Rate rises or falls, all U.S. credit cards with variable interest rates will increase or decrease by the same amount.
The difference between an interest rate and an APR may be good to know for many types of loans, but when it comes to your credit card, there's no difference at all. Read more here about understanding credit card interest rates.