At a Glance
When shopping for a loan and comparing lenders, you’ll come across several factors you’ll want to compare. Two of the most important factors are interest rates and APR. While those terms are sometimes used interchangeably, they mean two different things and both have an impact on your monthly payments and the overall cost of the loan. It’s important to consider both when determining which loan and lender are right for you.
Read on to learn more about:
What is the annual percentage rate?
The annual percentage rate, or APR, is the interest charged for borrowing that represents the actual yearly cost of the loan, expressed as a percentage. It also includes all potential fees and other costs. Essentially, it’s the bottom-line number for what a borrower is charged (on top of the sum of money they are borrowing).
Taking APR into account when shopping for loans is important because it’s the most accurate way to measure the true cost of the loan you’re borrowing, especially since it considers interest rates, fees, and other factors.
Learn more: Annual Percentage Rate on Personal Loan
How is APR calculated?
There are so many factors that go into calculating APR, including the loan amount, your credit score and history, your income, the lender, fees the lender charges, and more, so it can be difficult to determine a set number.
However, there is a general formula that can be followed:
APR = (((Fees+Interest)/Principal)/n)x365)x100
What does this mean? Interest is equal to the total interest sum paid over the life of the loan. The principal is the loan amount, and “n” represents the number of days in the loan term. Other costs may include:
- Discount points
- Origination fees
- Broker fees
- Insurance premiums (for a mortgage)
- Underwriting fees
What is the interest rate?
Interest rate is the percentage you pay to borrow funds from a lender. You’re then responsible for paying back the initial amount you borrow (the principal) plus any interest that accumulates.
Interest rates can be fixed, meaning they stay the same throughout the lifetime of the loan, or they can be variable, meaning they might change depending on market rates and other factors. Most personal loans have fixed interest rates, making it easier to budget for monthly payments and calculate how much interest you’ll owe over the life of the loan.
How much you pay in interest can depend on the interest rate and the term of the loan. For example, if you have a shorter term you’ll have a higher monthly payment, but you’ll end up owing less interest. A longer-term personal loan means lower monthly payments, but you’ll pay more in interest over the life of the loan.
Keep in mind that as you pay down the principal balance, you’ll also owe less in interest and a higher percentage of your payment goes toward your principal.
How are interest rates calculated?
Interest rates are calculated by factors both in and out of your control. For example, they are particularly determined by inflation, the economy, and the lender you choose to work with. However, other factors that play a role in your interest rate include your credit score and history, your income, your debt-to-income (DTI) ratio, and other pieces of information.
In most cases, the lower your credit score, the higher the interest rate you’ll be offered by a lender. The opposite also holds true – the higher your score, the lower the interest rate.
Related: Why a Good Credit Score Matters?
APR vs Interest rate
Why is APR higher than the interest rate?
APR can never be less than the interest rate, though they can be equal. In most cases, APR is higher than a loan’s interest rate because it considers more costs of borrowing. The interest rate states the rate at which interest will accrue on the loan’s balance, but APR includes interest and other fees or costs you may have to pay to borrow the loan. Because you’re adding additional costs to the interest, the APR will be higher.
Does 0% APR mean no interest?
Yes, 0% APR means you’re not paying any interest on the transaction. However, note that many 0% APR arrangements are temporary (for example, 0% APR for 12 months) but then have a higher APR after the introductory period is up. You may also still have up-front costs or fees.
Is it better to have a lower interest rate or lower APR?
The answer to this depends on whether you prefer to have the lowest possible monthly payment, or the lowest possible total loan amount.
- If you want a low monthly payment, get a lower interest rate.
- If you want a lower overall loan cost, get a lower APR.
Note that even if you have lower monthly payments, you may have a higher overall loan cost depending on your loan amount, loan term, credit score, and other factors.
Knowing what a good APR on a loan is depends on your financial and personal situation and needs. However, generally, you can expect the following based on your credit score:
|Score Range||Estimated APR|
|720 – 850||10.5%|
|690 – 719||15.5%|
|630 – 689||20.8%|
|300 – 629||26.1%|
APR can be equal to the interest rate, but it can never be less. This is because the APR takes into account the interest rate and other costs and fees associated with borrowing the loan. If there are no fees, the APR can be equal to the interest rate. But in most cases, it will be higher.
This depends on whether you want a lower monthly payment or a lower overall loan cost. If you plan to live in your home for a long time, a low interest rate may be more important. On the other hand, if you are looking to live in your home for a shorter period, a lower APR can make your purchase more profitable.