An annual percentage rate (APR) and interest rate both represent the annual cost of borrowing as a percentage of the borrowed amount. Lenders use your interest rate to calculate monthly payments and disclose the APR. APR includes some fees in addition to interest resulting in a more comprehensive annualized cost of borrowing.
What an Interest Rate Is
An interest rate is a variable or fixed cost a borrower pays to a lender, expressed as a percentage of the loan amount. Typically, it’s annualized and is used to calculate the payments made on a loan, like a mortgage. An interest rate doesn’t include any fees and can understate the overall cost of borrowing.
To better understand how an interest rate works, consider a one-year loan that has monthly payments. In this example, a $1,000 one-year loan with a 5% interest rate, would require $87.50 in payments every month, for a total of $1,050. The monthly payment is calculated by multiplying the interest rate by the principal, adding it back to the loan amount, and dividing by 12.
What an Annual Percentage Rate Is
An APR includes fees in addition to the interest rate and takes into consideration the size and timing of payments. It can be thought of as the annualized cost of borrowing expressed as a percentage. This makes it a complete summary of the cost of borrowing than an interest rate.
Using the same one-year $1,000 loan with a 5% interest rate from the previous example, we can examine how a fee affects the APR. If the lender charges a one-time $50 fee to get the loan, it would still have monthly payments of $87.50. However, your APR, which includes the fee would be 10.5%. This is because by paying a loan fee of $50 to get a $1,000 loan, you effectively only received $950.
When an Interest Rate Is Used
Interest rates are used to calculate your payments for financing products like business credit cards or mortgages. Savings accounts also have an interest rate quoted because in this case, the bank is borrowing your money. Lenders and borrowers usually both use the interest rate to determine the size of the payments that should be made.
When an APR Is Used
The Truth in Lending Act requires lenders to disclose the APR for all loans used for consumer purposes. Borrowers use the APR to compare different financing offers, which may have similar interest rates, but different repayment terms and fees. APR may also be quoted for business loans, although this is less common and not required by law.
However, be wary of only using APR to compare loans, because it may understate your total financing cost. In some circumstances, an APR may understate the total cost of the loan because some fees are omitted, or the interest rate is variable. It’s always important to discuss what is included in your APR with your lender.
Why APRs & Interest Rates Both Matter
Both APR and interest rates matter because they help you compare financing offers that may otherwise look similar. Two loans could have the same interest rate, but different APRs because of fees. Besides the APR and interest rate, you should also consider your total financing costs when comparing loans.
How APR Is Calculated
APR is calculated differently for different financing products. For example, a credit card APR is equal to its interest rate because your interest charges are calculated based on your daily outstanding balance, and fees are not included. However, when your lender calculates your APR for a mortgage, it will include certain fees like prepaid interest and points in the calculation.
Some fees typically included or excluded from your APR are:
|Typically Included in APR||Typically Excluded from APR|
|Points||Late Payment Fees|
|Prepaid Interest||Membership Fees|
|Loan Origination Fees||Notary Fees|
|Credit Guarantee Insurance Premiums||Documentation Preparation Fees|
|Mortgage Broker Fees||Title Insurance and Examination Fees|
The lender then uses your adjusted balance and interest rate to determine the size of your amortized monthly payments. Amortized monthly payments include both principal and interest and are calculated to be equal over the course of your loan. Using your amortized balance, your lender calculates your APR based on the amount of money you receive from the loan. This amount excludes the additional fees added to get the adjusted balance.
The math behind the final calculation is a little more complex. However, the key takeaway is that the guidelines for the process lenders must follow are outlined in the Truth and Lending Act, but every form of financing is different. Discussing which fees are included in the calculation, how they are paid, and anything that can change throughout the loan term with your lender is the best way to understand your APR.
APR vs Interest Rate: Mortgage Example
Most mortgages include fees; however, the way those fees are treated will impact your APR, monthly payments, and the total cost of borrowing, even if the interest rate is constant. In our example, we’ve used a typical 30 year, $300,000 mortgage with the same $5,000 fee to illustrate the impact it has, depending on how it’s treated in a mortgage APR calculation.
Based on a 30-year, $300,000 mortgage, you would have the following APRs and costs:
|Fees||None||Included & Financed||Included & Prepaid||Excluded|
Some interesting observations can be made using the table above. First, in scenarios where there are no fees or fees are excluded by the lender, the resulting APR is equal, but the total cost of the loan increases by the amount of the fees. Furthermore, prepaying or financing the included fees results in similar APRs. However, if you finance fees, your monthly payments and total costs increase because you are paying interest on those fees.
Therefore when you’re comparing a mortgage interest rate vs APR between multiple loans, it’s important to understand which fees are excluded by your lender. An excluded fee will not impact the interest rate or APR, but you still have to pay it.
APR vs Interest Rate: Credit Card Example
Your credit card interest rate and APR are equal because fees are not included in the APR calculation. However, the annual fees impact your total cost, along with other incidental fees (e.g., fees for late payments). When evaluating a credit card, your average daily balance, $10,000 in our example, is what credit card issuers use to calculate your payments.
A $10,000 average daily outstanding balance and 15% interest rate results in the following APR and total annual cost:
|Average Daily Outstanding Balance||$10,000||$10,000||$10,000|
|Total Annual Cost||$11,500||$11,600||$11,750|
As the table shows, your interest rate and APR are equal, even when your annual fee changes. However, the annual fee causes the total annual cost of borrowing to increase. Although the impact is not large in this example if you carry a lower average daily balance, the impact of an annual fee will be higher.
How to Calculate APR in Excel
If you’d like to calculate your APR to compare financing offers from several lenders, you have a few options. You could discuss it with your lender or use our APR calculator. Additionally, you could download our Excel APR spreadsheet to calculate APR. In our APR calculation, we assume you’re receiving a term loan, making equal monthly payments of principal and interest, prepaying all of your fees, and receiving a fixed interest for the entire term of the loan.
The three steps to calculating APR in Excel are:
- Enter your inputs: Enter your loan amount, interest rate, loan term, and fees.
- Solve for your monthly payments: Using the payment formula (=PMT). Make sure to multiply the loan term by 12 for the monthly payments and divide the interest rate by the same amount for monthly interest. You’ll notice that the payment is negative. This is because you will be making the payment in this case.
- Solve for your APR: Using the rate formula (=RATE), follow the same guidelines for the number of periods as the previous step. Make sure to subtract your fees from the total loan amount for the present value. Then multiply the output by 12 for the APR of your loan.
This will allow you to estimate your APR in excel. However, it’s important to discuss it with your lender because its calculation of the APR may be different. Some rates, like SBA loan rates, may vary until you apply for the loan, making them more difficult to predict. You can use our APR spreadsheet to estimate your payments and adjust repayment terms to select an affordable financing option.
APR vs Interest Rate: 6 Key Factors to Consider
Reviewing your APR and interest rate allows you to understand and compare your financing options better. However, there are other important factors to consider, such as the repayment term, fees, changes to the APR, payment structure, and how to evaluate potential rate reductions.
The six things to consider when completing an interest rate vs APR evaluation are:
1. What the Repayment Term Length Is
The repayment term of your loan typically won’t affect your interest rate or APR. This is because both rates are annualized, so adding additional time does not affect them, unless there are fees. However, extending the repayment term on a loan with a constant interest rate and APR increases the total financing and repayment cost as seen in the example below.
In this scenario, consider a 20 and 30-year mortgage, with the same interest rate and APR:
|Term||20 years||30 years|
2. Which Fees Were Included in the APR Calculation
Besides your interest, your APR includes certain fees charged by the lender to get the loan, like origination and mortgage broker fees. However, not every lender includes the same fees in its APR calculation, and different financing products like credit cards and mortgages have separate requirements.
It’s also important to understand how included fees are factored into the APR. When a fee is financed, the monthly payments include the loan amount and the financed fee. Your financing cost will reflect all the fees the lender is required to disclose, regardless of how they are paid.
3. What Might Cause the APR to Change
An APR may change is if the interest rate is variable. Variable rates are often tied to a market rate, like the prime interest rate, and the bank will use this rate to adjust your APR on an ongoing basis, typically annually. Additionally, APR may increase if there are late payments, deterioration of your credit score, or an increase in your credit utilization.
The Truth in Lending Act requires that your APR is disclosed at the time that you receive a loan offer, along with any potential changes to your APR that can take place. These will be outlined in your financing offer, and it’s important to understand each circumstance and the potential amount that your rate could increase.
4. How to Compare Rates Between Lenders
The best way to compare rates between lenders is with a loan estimate, which mortgage lenders are required to provide within three days of your application. In it, you’ll find disclosures of the loan amount, estimated interest rate, APR, monthly payments, closing costs, estimated taxes and insurance, and any penalties, like late payments that can affect your costs.
With other financing products, the best way to get this information is by discussing it with your lender. When comparing rates between lenders, it’s especially important to consider the fees that are not included in the APR and can impact your overall cost of borrowing. These fees are not included in your APR or monthly payments, but they can add up quickly and result in much higher payments and affect your total financing cost.
5. How Your Payments Are Structured
Your interest rate will help you determine the size of your monthly payments. However, the timing and size of each payment will only be included in the APR. If your payments increase over time or there are changes during the loan that impact the frequency of payments this will be factored into your APR.
As an example, two loans may have the same interest rate but different APRs. The first loan may have equal monthly payments that you can plan for. However, the second loan may have payments that start small and increase over time. This difference will only be reflected in your APR and may not be apparent if you only evaluate the interest rate.
6. When You Should Try to Lower Your Interest Rate
Some lenders will offer you the opportunity to lower your interest rate by paying discount points. This means that you will have greater upfront fees in exchange for a lower interest rate and lower APR over the course of the loan. However, to realize this benefit of the lower rates, the loan needs to remain outstanding for a certain number of years.
Work with your lender to understand how much time the loan needs to be outstanding before you start to benefit from the lower rates. For the first few years, your financing costs will be higher due to the upfront fees. However, with enough time, the lower interest will offset the cost of the discount points and start saving you money.
APR vs Interest Rate Frequently Asked Questions (FAQs)
In this article, we’ve done our best to compare APR vs interest rates are and explain how you can use each one. However, your particular financing situation may raise questions that we haven’t answered. We’ve gathered the most frequently asked questions about APR vs interest rates and answered them below. If your question was not answered, we invite you to ask it in the Fit Small Business Forum.
The most frequently asked questions about APR vs interest rate are:
Are interest rates and APR the same thing?
APR includes your interest rate and some fees resulting in a broader annualized cost of borrowing than an interest rate. Some common fees include mortgage broker fees and discount points. You can typically expect your APR to be slightly higher than your interest rate. However, with credit cards, the two are equal.
What is the difference between interest rate and APR on a credit card?
With a credit card, there is no difference between your interest rate and your APR. Although APR normally includes fees, in the case of credit cards fees are excluded from the calculation. This is why it’s important to consider the total cost of financing in addition to the APR when comparing credit card offers.
What is a good APR for a credit card?
Typically, low-interest credit cards have interest rates below 14%. According to the most recent Federal Reserve data, the average active credit card account APR in 2018 was 16.05%. However, introductory offers and rewards, are not accounted for in the APR. Typically, an APR below this average is considered good.
What is a good mortgage APR?
A good mortgage APR is typically 5% or less. Federal Reserve data indicates that the average rate for a 30-year fixed-rate mortgage in 2018 was 4.54%. Starting with this interest rate, you can typically expect an APR that is slightly higher, depending on the fees associated with your mortgage and your personal qualifications.
Bottom Line―Interest Rate vs APR
You should consider your APR and interest rate when evaluating your financing options. Although your APR contains the interest rate and fees, it’s your interest rate that will determine your monthly payments. Additionally, you should compare your total financing cost, because the APR is annualized, and doesn’t necessarily include all the fees.