APR vs Interest Rate Explainer

What is APR?

APR (Annual Percentage Rate) is the true cost of borrowing money, expressed as a yearly percentage. It includes both the interest rate and all fees and charges associated with the loan. APR gives you a more accurate picture of what you'll actually pay compared to the interest rate alone.

Why APR is More Honest Than the Interest Rate Alone

The interest rate only shows the cost of borrowing the principal amount. It doesn't include origination fees, application fees, annual fees, or other charges. APR includes all of these costs, so you can compare loans on an apples-to-apples basis. A loan with a 5% interest rate but $2,000 in fees might actually cost more than a loan with a 6% interest rate but no fees.

Common Fees That Affect APR

Upfront Fees: Origination fees, application fees, closing costs (for mortgages), and points (prepaid interest). These are typically paid at the start of the loan.

Ongoing Fees: Annual fees (common with credit cards), monthly service fees, and maintenance fees. These are paid periodically throughout the life of the loan.

All of these fees increase your total cost of borrowing, which is reflected in a higher APR than the stated interest rate.

APR for Credit Cards vs Installment Loans

Credit Cards: APR typically includes the purchase interest rate plus annual fees and other periodic charges. Credit card APRs are usually higher than installment loans because they're unsecured debt.

Installment Loans: APR includes the interest rate plus origination fees, application fees, and any other loan-related charges. For mortgages, APR does not include property taxes, insurance, or escrow payments—those are separate costs.

How to Use APR When Comparing Loans

When shopping for loans, always compare APRs, not just interest rates. The loan with the lowest APR is usually the cheapest overall. However, also consider: loan terms, prepayment penalties, flexibility, and lender reputation. Sometimes a slightly higher APR with better terms might be worth it.