Defining APR and Interest rate
And clearing up the confusion
September 11, 2012 by Scott Cahill
Quick question: “What’s the difference between APR and interest rate?”
Can you answer it? How about this one:
“How do each of these affect my loan payments?”
The answer I usually give to the first one is this: An interest rate is how much it costs to borrow the money, while the APR tells you what it cost to get the loan.
To get a bit more technical: APR is the interest rate plus any fees or costs that are rolled into the loan (origination, servicing, insurance products, etc.).
The answer to the second question is also fairly straightforward: the interest rate is what truly affects your monthly payment; APR doesn’t have much effect at all.
Check out this chart, and notice how the APR doesn’t do much to move the monthly payment:
This might seem counterintuitive, but when it comes to non-mortgage loans (or others with terms of more than a decade) a lower interest rate will trump a lower APR. This is because the term (or length) of the loan has a huge effect on the APR.
This isn’t to say that the APR should be ignored. It’s to note that it doesn’t really impact your wallet as much as the interest rate does. Also keep in mind that the longer the term, the lower the APR will be.
For most of you, however, the interest rate and monthly payment are the things you’ll worry about. But it is good to know how it all works so you can accurately compare loan products and credit offers.
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