Business Guides

APR vs. Interest Rate: Which Is Better to Price Your Loan?

Last updated on March 10, 2020

Jacques Famy Jr

As you plan for your future, sooner or later you’re going to have to take out a loan. Personal loans in the U.S. have increased by 10% in the last year, the average loan amount being upwards of $16,000. If you’re part of these statistics, you’ll need help shopping for a loan and deciding between APR and interest rate.

What’s the Difference?

If you’ve never taken out a loan before, the difference between APR and interest rate may seem inconsequential and probably confusing. But chances are if you are taking out a loan, you’re planning for your future, and for that, you want to be sure you’re making a sound financial decision.

Both interest rates and APR are reflected as percentages, usually on an annual basis, that tell you the cost of borrowing money. Lenders will typically quote you both interest rate and APR, which are both critical, but they represent very different charges that you’ll end up having to pay back. Choosing the right loan is essential, and we’re here to help you make a good decision for your future.

The differences between the interest rate and APR may not seem significant, but in reality, the difference could be thousands of dollars. If you’re only comparing interest rates between lenders, you might only be getting a cursory look at your monthly costs.

Over recent years, the number of websites where you can get loans has increased exponentially. It may seem like it’s easier than ever to get a loan because you can often do it from your computer in your own home, but you should still do plenty of research and consider talking to an expert before you sign up for a loan.

When shopping for loans, the interest rate and APR for the same loan may be a different number. This can be unclear, but let’s take a look at each one and see what the critical differences are so you can make an excellent financial decision.

Interest Rate 

 

An interest rate is what determines how much money you have to pay back in addition to the amount you take out for your loan. This percentage is applied to the amount of money you borrow and then determines how much your monthly payments toward the loan will be.

When shopping for a loan, you’ll see the interest rate expressed as a percentage and listed as either fixed or variable. Fixed interest rates will stay the same throughout paying off your loan, while variable rates are subject to change.

You’re more likely to have a variable rate when you take out a loan for a mortgage as opposed to a personal loan, and it will typically be adjusted once a year.

When you see interest rates listed, however, it doesn’t include any additional fees that you might have to pay. That’s why choosing a loan purely based on its low-interest rate, even though it may seem like you’re going to save money, may not be the right decision for you.

 Annual Percentage Rate (APR)

The annual percentage rate, or APR, is also expressed as a percentage, but it includes much more. APR on loan is a combination of the interest rate associated with your loan and any additional fees you might have to pay. These fees include things like discount points, origination fees, broker fees, and mortgage insurance. APR is the annual cost of your loan, including any additional fees combined into a single percentage.

If you don’t have any additional fees, your APR will be the same as the interest rate. However, you’ll most likely have to pay additional charges upfront when you go with an APR. Costs like origination fees can range from 2% to 5%. These fees will not affect your monthly payment, but they are something to take into consideration your total cost.

Because the APR includes additional fees you have to pay, it will often be reflected as a higher percentage than an interest rate. That’s why it’s essential to know the difference and not just compare two percentages when you’re looking for a lender.

When you’re speaking with a loan agent, be sure to ask them what is and isn’t included in their APR. APR includes many additional costs that interest rates don’t, but it may not include all of them. For instance, if a lender has to check your credit score, a credit report fee might not be included in the total APR.

Even though the APR will give you a better idea of the total cost you’re going to have to repay, it’s not the only thing to consider when you’re choosing a loan. For starters, you should have a good idea of your needs and your timeline.

To calculate APR yourself, you need to know:

  • The interest rate of the loan you’re going to be taking out
  • The total amount you’re planning on borrowing
  • The cost of any additional fees
  • The repayment terms

You can also use this helpful APR calculator from Experian. However, to be safe, you should get all of this information from your loan officer or directly from the lender to make sure that your quote is accurate. Don’t be afraid to ask too many questions; it’s both you and your loan officer’s job to make sure you’re informed to make the best decision.

What Should I Use to Price My Loans?

When you’re shopping for loans, you’re most likely going to be comparing the basic interest rate of different lenders. You want the lowest interest rate possible, but if you don’t examine each lender’s APR, you might think you’re getting a better deal than you are.

Since APR includes all of the extra costs associated with your loan, knowing the APR will give you a more realistic idea of what you’ll be paying over the life of your loan repayment. When you’re comparing, be sure to ask what both the interest rate and the APR are so you can accurately judge what you’re going to have to pay back.

Some important things to keep in mind when you’re shopping for a loan are:

  • How much do you need to borrow?
  • What can you afford to pay back every month?
  • Are your goals for your loan short-term or long-term?

While looking at a lender’s APR might give you a complete idea of the money you have to repay, it shouldn’t be the only thing that you’re looking at. Your specific financial situation and goals for your loan will significantly impact which loan and lender you end up choosing.

If you’re planning on paying off your loan quickly, a loan with fewer upfront costs, even though it may be a higher rate, might save you money over time. In this scenario, your best option may not be an APR, also though, in many other situations, it is.

How Is My Rate Calculated?

Several factors are used to determine the rate your lender can give you for a loan. First, as you might have guessed, it is the type of loan you’re going to be applying for. Lenders will also use your credit history and take into consideration how much debt you’re already in.

If you have good credit, and you’re not in a lot of debt, you may be able to get a lower rate because you may be deemed “low risk.” However, if the lender decides that you’re “high risk,” then you’ll probably be offered a higher rate in the case that you can’t pay the money back.

The length of repayment on your loan is also a contributing factor to your rate. If you take out a loan for a mortgage that you’re planning on paying back over 30 years, it will probably have a higher rate than a loan paid back over ten years. Because you’re paying the money back faster, your lender will offer you a lower rate as an incentive to save you money.

Which Rate Is Best For Me?

Unfortunately, there’s no clear answer to this question. Whether you choose a lender based on APR or interest rate depends on what kind of loan you’re looking for and what your financial situation is. For that reason, even though APR may give you a more comprehensive look at what you have to pay back, it shouldn’t be the only thing you consider. And finding the lowest APR may not be the best choice for you.

If you’re looking for a lower overall cost, you should probably focus more on the APR of a loan. On the other hand, if a lower monthly payment is more important to you, you should focus on finding a lower interest rate.

It’s also a good idea to talk to a loan officer or another kind of loan expert when you’re shopping for loans. You might think that you can pick out the right loan yourself by comparing rates and doing your research, but a loan officer is essential to helping you find the right loan for your specific financial situation.

How Do I Get a Good Rate?

Although interest rates are driven by prevailing rates for the specific kind of loan you’re looking for, part of what your interest rate will be is determined by things like your credit score. You might look at loan estimates across different lenders and be able to compare rates, but they’re not the same for everyone.

The loan estimate is determined without considering any personal credentials. For example, the higher your credit score, the lower your interest rate will be. Because everyone’s credit score is different, each person’s actual rate that they are offered will be different. The principal balance also has a lot to do with what your monthly payment will be.

That’s why it’s essential to talk to an expert when you’re shopping for a loan. You might be able to do your research and get a good idea of loans between lenders, but until they know a little more about you, you won’t be able to get an accurate quote on an interest rate or APR.

Getting the best rate for your financial situation also requires you to do some planning. For example, if you’re taking out a loan for a home, you’ll want to consider how long you’re going to be living in your home. If you plan on being there for 30 years, you’ll most likely want a loan that has the lowest possible APR. This option will save you money in the long term.

On the other hand, if you’re only planning on being in your home for a few years, it might make more sense to pay a higher interest rate and a higher APR with fewer upfront fees. This could save you money if your plans are more short-term.

Final Thoughts

We’ve said it a few times throughout this guide, but it bears repeating. If you take anything away from this post, it’s that APR and interest rates are not the same, but both should be taken into account when you’re shopping for a loan. Interest rates are easy to compare, but they should never be the only thing that you ask for when you’re comparing lenders.

A lender’s APR will include more of the total costs that you’re going to have to pay in conjunction with your monthly payments, but you should ask your loan officer what both the interest rate and the APR are before deciding on a loan.

Before getting these rates, you should discuss what your goals are and what your financial ability is in terms of repayment. Having a solid understanding of your finances will help you choose the right loan and make the conversation you have with your loan officer much more manageable.

Making big financial decisions about your future can be stressful, especially if you’re not well-versed in the world of loans. But learning more about your options is a great first step towards making the right decision for you.

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