When it comes to credit, the interest rate and annual percentage rate (APR) are two factors that are likely to influence your selection. But what’s the difference between an interest rate and an annual percentage rate (APR)?
The cost of borrowing money is represented by both phrases. They aren’t, however, the same thing. Understanding the distinctions between interest rate and annual percentage rate can also help you make better credit decisions. Continue reading to discover more about the two words, how interest rates and APRs are calculated, and which one you should use when comparing loans.
What Is an Interest Rate (IR)?
According to the Consumer Financial Protection Bureau, an interest rate is the cost of borrowing money from a lender (CFPB). The interest rate is levied on the principle loan amount and is stated as a percentage. The card balance would be the loan amount on a credit card.
What Is Annual Percentage Rate (APR)?
The annual percentage rate (APR) is equivalent to the interest rate. However, as the Consumer Financial Protection Bureau says, “APR is a broader indicator of the cost of borrowing money.” This is because the annual percentage rate (APR) covers not only the interest rate but also various additional charges, such as lender fees, closing costs, and insurance.
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Keep in mind that a credit card’s interest rate and annual percentage rate (APR) may be the same. However, this may not be true for all loans.
Consider a mortgage, for example. As the CFPB explains, when it comes to a mortgage, “The APR reflects the interest rate, any points, mortgage broker fees and other charges that you pay to get the loan. For that reason, your APR is usually higher than your interest rate.”
How Are IR and APRs Determined?
The method for calculating interest rates and APRs differs depending on the type of credit or loan.
According to the Consumer Financial Protection Bureau, your credit card issuer may pick the interest rate or APR to charge you depending on criteria such as the information in your application and your credit history. In general, the better your credit score, the cheaper your interest rate or annual percentage rate will be.
This is also true when it comes to loans. However, lenders may consider additional aspects such as the down payment and the loan length. For example, the lower the interest rate or APR, the bigger the down payment.
Variable vs. Non-Variable Rates
The interest rate, often known as the annual percentage rate, can be variable or fixed. A variable rate is generally based on an index that lenders use to calculate their own interest rates, such as the prime rate. A variable rate, on the other hand, may alter in response to changes in the prime rate.
A non-variable rate is one that does not fluctuate over time, but it can alter under specific conditions. If you make late or missed payments, for example, your non-variable rate may rise. However, it is dependent on your lender’s rules as well as the conditions of your credit card or loan.
How Are Interest Rates and Annual Percentage Rate Calculated?
Lenders calculate the amount of interest you’ll pay using their own calculations. And the method for calculating the APR may differ depending on the type of credit or loan. For example, include discount points, fees and other charges in their calculations.
Depending on the card, interest might be computed daily or monthly for credit cards. The CFPB says that “Many issuers calculate the interest you owe daily, based on the average daily balance.”
If this is the case with your card, your issuer may keep track of your balance on a daily basis, adding charges and deducting payments as they come in. At the end of the billing cycle, all of the daily amounts are put together. To get your average daily balance, divide the sum by the number of days in the billing cycle.
Keep in mind that credit card companies may charge one rate for purchases and another for balance transfers and cash advances.
The terms and conditions of your card will provide a detailed explanation of how your issuer calculates interest. You may also learn more about credit card APRs by reading this in-depth look at how they’re calculated.
Should You Look at IRs or APRs to Compare Credit Offers?
The sort of credit or loan you’re asking for will determine whether you should compare interest rates or APRs when comparing credit offers.
When comparing credit card offers, interest rate and APR can be used interchangeably. However, keep in mind whether the rate is variable or fixed, as a variable rate might vary.
And keep this in mind from the CFPB: “On most cards, you can avoid paying interest on purchases if you pay your balance in full each month by the due date.”
When it comes to mortgages and other forms of loans, comparing APRs may be very useful because they include not just interest but also other charges. You may estimate how much a lender’s fees will cost you by subtracting the interest rate from the APR.
When evaluating loan offers, it’s important to look at more than just the interest rates and APRs. Annual fees, necessary down payments, and loan conditions are just a few items to think about.
Understanding the Differences between Interest Rate and Annual Percentage Rate
The cost of borrowing money is represented by both the interest rate and the annual percentage rate (APR). They’re also both stated in percentages. In most cases, the interest rate and the annual percentage rate (APR) on credit cards are the same. However, because it incorporates the interest rate as well as certain other expenditures, the APR can more properly represent the cost of borrowing for other loans.
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You can make a more informed selection when looking for credit now that you understand the distinctions between interest rate and APR.
When you’re looking for a property, you’ll notice two interest rates: your interest rate and your annual percentage rate (APR). While your interest rate is the amount of interest you pay on your loan, your APR includes both your interest rate and any other fees or charges you’ll have to pay to your lender. Brokerage fees, private mortgage insurance, and discount points are some of the most typical extra expenses. Consider your APR to be the effective interest rate you’ll pay once you’ve received your loan.
Before you finalize on a loan, lenders must disclose you both your interest rate and your annual percentage rate (APR). Controlling your credit score and opting for a government-backed loan might help you save money on interest. However, because many of these charges are established by the lender, you have little control over your APR. However, comparing identical loan packages with other lenders is the best approach to discover a cheaper APR.