APR vs. Interest Rate: What's the Difference?

Two numbers show up on nearly every borrowing offer: the interest rate and the APR. They sound alike, and sometimes they are identical, but they measure different things. Knowing the difference makes it easier to compare offers on equal terms and to understand what borrowing will actually cost.

The interest rate: the price of the principal

The interest rate is the percentage charged on the amount you borrow, called the principal. It determines how much interest builds up on the balance over time. If you borrow $10,000 at a 10% interest rate, that 10% is what the monthly payment schedule is based on.

The interest rate does not include fees. It only describes the cost of borrowing the money itself.

Interest rates can be:

• Fixed, staying the same for the life of the account
• Variable, moving up or down with a benchmark index, such as the prime rate

APR: a broader yearly cost

APR stands for annual percentage rate. It starts with the interest rate and folds in certain required fees, then expresses the total as a yearly percentage. The idea is to give borrowers one number that reflects more of the true cost.

Under the federal Truth in Lending Act, lenders must disclose the APR before you sign. Fees that are commonly included in APR for installment loans and mortgages may include:

• Origination or processing fees
• Certain broker or points charges on mortgages
• Some required insurance premiums

Not every cost is included. Late fees, returned payment fees and optional add-ons are generally left out, so it still pays to read the full fee schedule.

Why fees are spread across the year

An upfront fee is paid once, but APR treats it as part of the yearly cost over the full term. On a short term, the same fee is spread across fewer months, so it pushes the APR up more. On a longer term, it is spread more thinly. That is one reason two offers with the same fee and interest rate can show different APRs when their terms differ.

Why the two numbers diverge: a worked example

Fees are what create a gap between the interest rate and the APR. Here is how that works on a personal loan.

Say you borrow $10,000 for 36 months at a 10% interest rate, with a $400 origination fee taken out of the funds before you receive them.

• Monthly payment at 10% on $10,000 over 36 months: about $322.67
• Total of payments: $322.67 × 36 = $11,616.12
• Amount actually received: $10,000 − $400 = $9,600
• Total cost of borrowing: $11,616.12 − $9,600 = $2,016.12

The interest rate is 10%, but you are making payments on $10,000 while only receiving $9,600. When the same $322.67 monthly payment is measured against the $9,600 you actually received, the yearly rate works out to about 12.8%. That figure is the APR.

Now compare a second offer: a 12% interest rate with no origination fee. Its APR would also be 12%. In this example, the offer with the lower interest rate (10%) has the higher APR (about 12.8%). Looking only at the interest rate would point you toward the more expensive choice.

You can test different rates and terms with the interest cost estimator.

How APR works on credit cards

Credit cards are a special case. Most cards do not charge an origination fee, so the purchase APR and the interest rate are usually the same number. A card may also list several APRs:

• Purchase APR for everyday charges
• Balance transfer APR for balances moved from other cards, sometimes with a promotional period
• Cash withdrawal APR, often higher and usually with no grace period
• Penalty APR, which may apply after a late payment

From yearly to daily

Cards usually apply APR as a daily periodic rate. You can find it by dividing the APR by 365.

Say a card has a 21.99% APR and your average daily balance for a 30-day billing cycle is $1,500.

• Daily periodic rate: 21.99% ÷ 365 ≈ 0.0602% per day
• Interest for the cycle: $1,500 × (0.2199 ÷ 365) × 30 ≈ $27.11

Issuers calculate this in slightly different ways, and some compound daily, so your statement figure may differ by a small amount. If you pay the full statement balance by the due date, most cards charge no interest on new purchases because of the grace period.

How to use APR when comparing offers

APR is a helpful comparison tool, but it works best alongside other numbers. When reading any offer:

1. Compare APR to APR. Comparing one offer’s interest rate to another’s APR is not an even comparison.
2. Match the terms. A 36-month offer and a 60-month offer can have similar APRs and very different total costs.
3. Look at total interest. Multiply the monthly payment by the number of months, then subtract the amount received.
4. Check if the rate is fixed or variable. A variable APR can rise later.
5. Consider early payoff. If you expect to pay early, an upfront fee makes the effective cost higher than the stated APR.
6. Read the full fee list. Some charges are not part of APR at all.

None of these steps require special software. A calculator and the written disclosure are usually enough.

Next steps

• Estimate total interest for any rate and term with the interest cost estimator.
• See how installment terms fit together in How Personal Loans Work.
• Learn where each APR appears in card terms with How to Read a Credit Card Agreement.
• Explore more guides in the Borrowing Basics section.