APR vs Interest Rate: What the Difference Means for a Loan
Loan adverts give a headline interest rate, and the small print gives an APR. They are usually close but rarely identical, and the gap between them can tell you a lot. Two loans with the same interest rate can have different costs, and a loan with a higher rate can sometimes be the cheaper one.
This guide explains what each figure measures, works through a loan with an upfront fee, compares two offers side by side, and covers the limits of APR as a yardstick.
What each figure measures
The interest rate is the price charged for borrowing the principal. It is applied to the balance to work out interest, and it is the number that goes into the payment formula.
The APR, or annual percentage rate, is an attempt to express the whole yearly cost of the loan as a single rate. It starts with the interest and also takes in certain mandatory charges, such as an origination fee, spread over the life of the loan. Lenders in many countries are required to quote it so that offers can be compared on one basis. Exactly which charges count differs between countries and between types of loan.
If a loan has no qualifying fees, the APR and the interest rate are the same. The more fees that are charged at the start, the further the APR rises above the rate.
A worked example with a fee
Example: a 10,000 loan over 36 months at an 8% interest rate, with a 2% origination fee. The fee is 200, taken out of the proceeds, so you receive 9,800 but repay as if you had borrowed 10,000.
- Monthly payment on 10,000 at 8% for 36 months: 313.36.
- Total repaid: 313.36 × 36 = about 11,281.
- Real cost: 11,281 repaid − 9,800 received = about 1,481, not the 1,281 of interest alone.
- APR: the annual rate at which payments of 313.36 repay a 9,800 loan over 36 months comes out at about 9.38%.
The APR is higher than 8% because you pay interest on 10,000 while having the use of only 9,800. There is no simple closed formula for step 4; it is found by trial and error or with a financial function, which is why a calculator is useful. The loan calculator gives the payment and total repaid.
Comparing two offers
Both loans below are for 10,000 over 36 months. The fee is deducted from the amount you receive.
| Measure | Offer X | Offer Y |
|---|---|---|
| Interest rate | 7.5% | 8.2% |
| Upfront fee | 3% (300) | None |
| Monthly payment | 311.06 | 314.29 |
| Amount received | 9,700 | 10,000 |
| Total repaid | 11,198 | 11,314 |
| Cost of borrowing | 1,498 | 1,314 |
| APR | 9.58% | 8.20% |
Offer X has the lower rate and the lower payment, which makes it look better at first sight. But after the fee it costs about 184 more over the three years, and its APR is more than a full percentage point higher. Here the APR points to the cheaper loan correctly.
Limits of APR
- It depends on the term. A fee spread over a short loan weighs more than the same fee spread over a long one. The 8% loan with a 2% fee above has an APR of about 11.82% over 12 months but about 8.86% over 60 months.
- Early repayment changes the picture. If you repay early, the upfront fee is spread over fewer months, so the true cost per year is higher than the quoted APR.
- Variable rates are estimates. For loans where the rate can change, the quoted APR typically assumes the current rate stays in place.
- It is not the same everywhere. The rules for which fees count, and how the figure is annualised, differ by country and product.
Comparing offers in practice
- Ask each lender for the amount you would receive, the interest rate, the term, every upfront fee and the monthly payment.
- Compare the APRs first, but only for loans with the same term, since a fee weighs differently on a short loan and a long one.
- Work out the cost of borrowing: total repaid minus the amount you actually receive.
- Ask whether there is a penalty for repaying early, because that can change which loan is cheaper if you plan to clear it sooner.
Do not confuse APR with APY, the annual percentage yield, which includes the effect of compounding. In the US an APR is generally a nominal figure, such as the monthly rate multiplied by 12, while in some other countries it is calculated as an effective annual rate, so check how the figure is defined where you borrow. With monthly compounding, an 18% APR corresponds to an APY of about 19.56%, and the APY calculator does that conversion. The article on APR vs APY covers it in detail.
This article is general education, not financial advice. Rules on APR disclosure differ by country, so check the official loan documents and ask the lender to explain any figure you do not understand.
- Loan Calculator: Enter the amount you want to borrow, the term, the interest rate and how often you will pay. You get the size of each payment, the total you will repay and the interest you will pay.
- APY Calculator: Enter the stated interest rate and how often it compounds to get the annual percentage yield. Add a starting balance and a term to see the interest it earns.
This article is general information, not professional advice. See our Disclaimer and Editorial Policy.
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