Interest Rate vs. APR: What's the Difference?
When you find yourself applying for a loan, two terms you’re guaranteed to come across are “interest rate” and “annual percentage rate” (APR). And if you’re new to the world of finance, you’ll also find yourself wondering what on Earth they mean and what their significance is for you. Fortunately, we’re not about to let you go at this alone. Below, we’ve got a quick run-through of what these terms typically mean, how they can impact your decision to take out a particular loan, and how much you will be paying for that loan over time.
What is Interest Rate?
Essentially, interest rate is the amount you’re being charged to borrow money. At the beginning of a loan, you borrow a certain amount—this is called the “principal” amount. An interest rate is expressed as a percentage of the principal; so if you took a $10,000 loan to buy a car, and have to repay 3% interest on that loan, $10,000 is the original principal amount, and 3% is the interest rate. In that example, at the end of the year, you would owe $300 in interest—essentially, you’ve paid $300 in exchange that year in exchange for borrowing the $10,000. It should be noted, though, that an interest rate only takes into account the amount of principal being borrowed. As described below, there are often other costs associated with taking a loan that you should consider.
An interest rate can either be variable, meaning it can change over time, or fixed, meaning the amount of interest remains the same. At Climb, our interest rates are fixed, so you don’t have to worry about your interest rate rising unexpectedly!
What is APR?
Annual percentage rate is also expressed as a percentage. (We know, you probably could have guessed that from the fact that the word “percentage” is in the name.) However, it differs from an interest rate in that it represents the entire cost over the term of the loan. This means it includes fees or any other additional cost of borrowing.
Lenders can vary widely in the structures of their loans and the fees they include. Having a standard calculation such as APR means that you can easily compare what different loans will actually cost you.
What Does It Mean for You?
Because interest rate only refers to the interest on the principal and APR takes other costs into account, the latter tends to be higher. It’s important to keep in mind the rate of your interest, as that will impact your regular, periodic payments; however, APRs are what you should compare when looking at two different loan options. By law, lenders are required to disclose the annual percentage rate in order to ensure transparency and a clear understanding of the agreement on the part of the borrower; this way, you can’t be given a quote for a low interest rate and then be surprised later by fees that result in a high APR!