Marcio Vasconcelos
When shopping for loans or mortgages, you’ll frequently encounter the terms APR (Annual Percentage Rate) and interest rate. Knowing the distinction between these two can significantly impact your financial decisions. Read on to learn what APR and interest rate are, how they differ, and when to consider each.
What is an Interest Rate?
The interest rate is the cost of borrowing money, expressed as a percentage of the loan amount. It is the amount lenders charge for the use of their money. Interest rates can be fixed, meaning they remain constant throughout the loan term, or variable, meaning they can change based on market conditions.
For example, If you take out a $100,000 mortgage with an interest rate of 4%, you'll pay $4,000 annually in interest.
Learn more:
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What is APR (Annual Percentage Rate)?
APR includes the interest rate plus other costs associated with taking out a loan, such as origination fees, mortgage insurance, and closing costs. APR provides a more comprehensive view of the total cost of the loan over a year.
If the same $100,000 mortgage has an interest rate of 4% but includes $3,000 in fees, the APR might be 4.3%. This reflects the interest plus the additional costs spread over the loan term.
Comparing APR and Interest Rate
Similarities
- Purpose: Both APR and interest rate measure the cost of borrowing money.
- Expression: Both are expressed as percentages.
- Impact: Both affect the overall cost of a loan and the monthly payment amounts.
Differences
- Scope: The interest rate only includes the cost of borrowing the principal amount, while APR includes the interest rate plus additional fees and costs.
- True Cost: APR provides a more comprehensive picture of the total loan cost, including fees such as origination fees, closing costs, and insurance.
- Usage: Interest rate is typically used to calculate monthly payments, while APR is used to compare the overall cost of different loan offers.
Should I Go By APR or Interest Rate?
When to Use APR
Comparing Loan Offers:
Use APR to compare the total cost of different loan offers, especially when lenders have varying fees. APR provides a comprehensive view of the true cost over a year, including interest rates and additional fees.
Long-Term Costs:
If you want to understand the long-term cost of a loan, APR is more accurate as it includes all associated costs.
Learn more:
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When to Use Interest Rate
Monthly Payments:
Focus on the interest rate if you are primarily concerned with your monthly payments. The interest rate directly affects the amount you will pay each month.
Basic Borrowing Cost:
Use the interest rate to understand the basic cost of borrowing the principal amount, especially if additional fees are minimal or comparable between offers.
FAQs
Can APR Be Equal to or Less Than the Interest Rate?
Typically, APR (Annual Percentage Rate) is higher than the interest rate because it includes additional fees and costs associated with the loan. However, there are certain scenarios where the APR can be equal to or even less than the interest rate:
- No Additional Fees: If a loan has no additional fees or costs, the APR will be equal to the interest rate. This is rare but can occur with certain types of loans or promotional offers.
- Rebates or Credits: Sometimes lenders offer rebates or credits that reduce the overall cost of the loan. If these rebates offset some of the interest or fees, the APR could theoretically be lower than the interest rate, though this is highly uncommon and usually temporary.
What Is a Good APR?
A good APR varies depending on the type of loan and current market conditions. Here are some general benchmarks:
Mortgage Loans:
A good APR for a mortgage loan is typically within 0.25% to 0.50% above the interest rate. For example, if the interest rate is 3.5%, a good APR would be between 3.75% and 4.0%.
Why is My APR Higher Than My Interest Rate?
APR is higher than the interest rate because it includes additional costs like loan origination fees, mortgage insurance, and closing costs. These extra charges increase the total cost of the loan, reflected in a higher APR.
Is Purchase APR the Same as Interest Rate?
No, the purchase APR includes the interest rate plus any additional costs associated with obtaining the loan. The interest rate alone does not account for these extra costs.
Is APR Monthly or Yearly?
APR is an annual rate. It represents the total cost of borrowing over one year, including interest and additional fees. This annual rate helps borrowers compare the full cost of loans over a standardized period.
How to Get the Best Loan Rates
Improve Your Credit Score:
A higher credit score typically qualifies you for lower interest rates. Pay off debts, avoid late payments, and monitor your credit report regularly to improve your score.
Shop Around:
Compare rates from multiple lenders, including banks, credit unions, and online lenders. Each lender may offer different rates and terms, so it’s important to see a variety of offers.
Consider the Loan Term:
Shorter loan terms generally come with lower interest rates. While your monthly payments may be higher, you’ll save on interest over the life of the loan.
Increase Your Down Payment:
A larger down payment reduces the lender’s risk and can result in a lower interest rate. Aim for at least 20% down to get the best rates on a mortgage.
Lock in Your Rate:
If rates are rising, ask your lender if you can lock in your rate when you apply for the loan. This ensures that the rate won’t increase before closing.
Negotiate:
Don’t be afraid to negotiate with lenders. Ask if they can offer better terms or match lower rates from competitors.
Use Points:
Consider buying discount points to lower your interest rate. Each point typically costs 1% of the loan amount and can reduce the rate by about 0.25%.
Maintain Stable Employment:
Lenders look for stability, so having a steady job and consistent income can help you secure a lower rate.
Get Pre-Approved:
Getting pre-approved for a loan can make you more attractive to lenders and might help you secure a better rate.
