Key takeaways
- The interest rate is the price of borrowing the money. The APR adds certain lender fees and expresses the total as a yearly rate.
- A $25,000 personal loan at 7% with a 5% origination fee has an APR of about 9.175%.
- Use APR to compare the same type of loan with the same term. Then check the dollar fees and how long you’ll keep the loan.
- APR assumes you keep the loan for its full term, so it favors high-fee, low-rate loans more than it should if you’ll pay off early.
Every loan offer shows two percentages, and the difference between them is the fees. Knowing how they relate helps you compare loans and spot when a “low rate” isn’t actually cheap.
The interest rate: what you pay on the balance
The interest rate, sometimes called the note rate, is what the lender charges on your outstanding balance. It sets your monthly payment. A $25,000 loan at 7% over five years has a payment of $495.03, no matter what fees come with it.
The APR: rate plus fees
The annual percentage rate folds in the finance charges you pay to get the loan, such as origination fees, discount points, and on mortgages, mortgage insurance. It’s the rate at which the payments you’ll make equal the money you actually receive.
Say that $25,000 personal loan has a 5% origination fee ($1,250) taken out of the proceeds. You receive $23,750 but repay $495.03 a month on the full $25,000. The rate that balances those is the APR: 9.175%, well above the 7% note rate.
The Truth in Lending Act requires lenders to show the APR prominently, precisely so borrowers can compare offers with different fee structures.
Comparing two mortgage offers
Two lenders quote a 30-year, $320,000 mortgage:
| Offer A | Offer B | |
|---|---|---|
| Interest rate | 6.25% | 6.625% |
| Points and lender fees | $7,700 | $2,500 |
| Monthly principal & interest | $1,970.30 | $2,049.00 |
| APR | 6.482% | 6.701% |
Offer A has the lower rate and the lower APR. But it costs $5,200 more upfront to save $79 a month.
That’s the catch with APR: it spreads the fees over all 30 years, and most people don’t keep a mortgage that long. What matters is the cost over the time you’ll actually hold the loan, meaning fees, plus payments, plus the balance you pay off when you sell or refinance:
| If you keep the loan | Offer A | Offer B | Cheaper |
|---|---|---|---|
| 3 years | $386,642 | $385,054 | B, by $1,589 |
| 5 years | $424,597 | $425,422 | A, by $825 |
| 10 years | $513,696 | $520,508 | A, by $6,812 |
The lower rate also pays the balance down a little faster, so Offer A catches up sooner than the payment difference alone suggests. But for a short stay, the higher-APR loan with lower fees can be the cheaper one.
What APR includes and leaves out
Usually included:
- Origination and underwriting fees
- Discount points
- Mortgage insurance premiums
- Some broker fees and prepaid interest
Usually not included:
- Appraisal, credit report, and inspection fees
- Title insurance and settlement fees (in most cases)
- Property taxes, homeowners insurance, and escrow deposits
- Late fees and other charges that depend on how you use the loan
So two mortgages with identical APRs can still need different amounts of cash at closing. Your Loan Estimate breaks every cost out.
How to use APR well
- Compare like with like. Same loan type, same term, same day. A 15-year and a 30-year loan’s APRs aren’t comparable.
- Check the fees in dollars. A lower APR bought with large upfront fees only pays off if you keep the loan a long time. See discount points and the refinancing break-even.
- Watch variable rates. An adjustable-rate loan’s APR is based on assumptions about future rates, so it’s a rough guide at best.
- Don’t confuse APR with APY. APR ignores compounding. APY, used for savings, includes it. See APY vs. APR.