Understanding Interest and APR: A Comprehensive Guide
At O1ne Mortgage, we prioritize consumer credit and finance education to help you make the best decisions when it comes to borrowing money. Whether you’re looking for a mortgage, auto loan, student loan, or personal loan, understanding the difference between interest and APR (Annual Percentage Rate) is crucial. This guide will provide you with the knowledge you need to make informed decisions and find the best loan options available. For any mortgage service needs, feel free to call us at 213-732-3074.
What Is Interest?
Interest is the cost a borrower pays to borrow money, typically expressed as a percentage of the amount borrowed. Whether you’re taking out an installment loan like a mortgage or using revolving credit such as a credit card, you’ll usually pay interest on your balance until it’s fully repaid.
How Are Interest Charges Calculated?
Interest charges are calculated as a percentage of your loan amount. For example, if you borrow $30,000 to buy a car at an interest rate of 5% over 60 months, you would pay a total of $3,968 over the life of the loan. Calculating interest on a credit card can be more complex, as it is based on your average daily balance and the daily interest rate, which is your card’s annual rate divided by 365. To simplify this, you can use a credit card payoff calculator to figure out your interest charges.
The interest rate you’ll qualify for depends on your creditworthiness and is also influenced by benchmark rates set by the Federal Reserve.
What Is APR?
APR, or Annual Percentage Rate, represents the true cost of borrowing money with an installment loan. It includes the loan’s interest rate plus any additional charges, such as:
- Origination fees
- Closing costs
- Mortgage insurance
- Mortgage points
Because APR includes both fees and interest bundled into one number, it provides a clearer picture of the total cost of a loan. It’s the rate to look at when comparing different loan options to find the most affordable one.
How Is APR Calculated?
APR is represented as a percentage of the amount borrowed, similar to interest. However, calculating a loan’s APR takes into account all other costs associated with the loan. For example, a $10,000 personal loan with an interest rate of 13% and an origination fee of $400 repaid over three years has an APR of 15.77%.
For credit cards and other types of revolving credit, such as home equity lines of credit (HELOCs), APR is the same as the loan’s interest rate and doesn’t include fees. In these cases, the terms APR and interest rate are interchangeable and can be used to compare multiple credit cards.
What’s the Difference Between Interest and APR?
While both interest rate and APR reflect the cost of borrowing, APR provides more comprehensive information about what you’re paying—except in the case of credit cards. Generally, the two biggest factors that dictate what you’ll repay when you take out a loan are the principal borrowed and the interest rate. However, you’ll also want to consider costs such as origination fees and other lending fees, as they impact what you will ultimately repay. Instead of looking at interest alone, APR helps you see all these costs at a glance.
This makes APR a more accurate way to understand a loan or compare two loans. For example, if two loans have the same interest rate but different APRs, the loan with the lower APR will often be the better deal.
APR vs. Interest Rate
| APR | Interest Rate |
|---|---|
| The total cost to borrow money as a yearly percentage of the loan amount | The rate you pay a lender to borrow money as a percentage of the loan amount |
| Includes interest and all lender or broker fees, such as an origination fee | Doesn’t include fees |
| Can give you a more complete look at how much you’ll really pay to borrow | While a lower interest rate typically means a more affordable loan, look at APR for an apples-to-apples comparison when loan shopping |
Why Is APR Higher Than Interest?
APR is generally higher than interest because it takes into account not just a loan’s interest rate, but also any fees associated with the loan. In some cases, such as when a loan has no fees, APR may be equal to the interest rate.
The Bottom Line
Knowing the difference between interest and APR can help you evaluate the best loan for you. What lenders will charge you to borrow largely depends on your credit report and score. Before exploring loan options, check your credit score to understand where you stand. You can also sign up for free credit monitoring through Experian to receive regular updates and pinpoint areas where you may be able to improve your credit. Taking these steps now can help you save money when you’re ready to borrow.
At O1ne Mortgage, we are committed to helping you find the best loan options available. For any mortgage service needs, call us at 213-732-3074. Our team of experts is here to assist you every step of the way.
