The content of this article is provided for informational purposes only. You should always obtain your own independent, tax, financial, and legal advice before making any material decision.
Key takeaways:
Many payers don’t know much about the calculations behind their credit card and loan payments. Plus, credit card companies and lenders don’t have to notify customers of rate changes.
The result is that many people may be unaware of their credit card annual percentage rate (APR) or are unable to locate interest rates.
Borrowers may need to consider the differences between APR vs. interest rates to make informed decisions, especially since there are many key factors to consider when researching financing and borrowing. The differences between these two rates can impact potential charges, which can affect budgeting and savings.
In this article, we explore interest rate vs. APR, how they’re calculated, and how they affect repayable amounts.
The APR is the total cost of borrowing for a year and includes:
APR is shown as a percentage and may help borrowers compare the total cost of loans or credit cards from different lenders. These rates can also fluctuate based on an individual’s credit score, credit history, and financial situation. Additionally, finalized APRs can vary based on lender, borrower, down payment (if applicable), and type of credit applied for.
Important note: When applying to borrow money, it’s common to see a representative APR, which is a placeholder value and not necessarily the rate a borrower will receive. The borrower generally sees the true APR when they receive a loan or credit card term agreement.
APR is calculated by considering the interest rate, fees, and loan amount, then multiplying the cost by a year. If a balance still exists after each grace period, even if the minimum credit card payment is made, the APR is applied.
The APR formula looks like this:
APR = [(((Interest + fees)/Loan amount)/Days in loan term) x 365] x 100
For example, if a borrower took out a loan for $1,000 with a 5% interest rate and $50 in additional fees for one year, the APR would be calculated using:
In this example, the APR for the loan would be 10%, and the total cost of the loan would be $1,100.
The interest rate is the fee that lenders add to the amount of money borrowed each month, also known as the percentage of interest on a balance. Credit card interest and loan interest rates are shown as a percentage, and most types of borrowing include an interest rate, except for no-interest loans or interest-free credit cards.
There are different types of interest rates, including:
The higher the interest rate, the higher the total cost of borrowing. Additionally, issuers only apply credit card interest when a borrower doesn’t pay the balance in full at the end of a statement period. This amount can depend on the original interest rate or the current variable rate.
Important note: Borrowers with variable interest rates can review their statements and terms to determine the exact rate for a given statement period.
Interest is calculated by multiplying the original loan amount by the interest rate and time.
The simple interest formula can look like this:
Interest = Loan amount x Interest rate x Time
Using the same example as calculating APR, if a borrower took out a loan for $1,000 with a 5% interest rate for one year, the interest would be calculated using:
This would make the amount of interest $50. The total repayable amount would then be $1,050. However, this does not consider any fees and therefore may not accurately show the total cost of borrowing.
The main difference between interest rates vs. APR is that the interest rate shows the cost of borrowing but does not factor in additional fees. APR includes interest and fees, so it may give a more accurate total cost of borrowing.
Low interest rates do not necessarily mean a lower cost of borrowing. Loans with high fees can have higher APRs, which may result in a higher total cost.
Whether an individual is getting a credit card or applying for a mortgage loan, the recommendations below can help lower interest rates.
Credit scores may impact the rates offered by lenders. Higher credit scores can signal reduced risk, which can result in more favorable loan terms and lower interest rates.
Responsibly managing revolving credit by maintaining low balances and making consistent, on-time payments can sometimes be an effective strategy for improving credit scores.
However, demonstrating financial reliability in other ways can also help transition a lower credit score into good credit, making borrowing more affordable and accessible.
Government-backed loans can help reduce borrowing costs by offering lower interest rates and more accessible terms than conventional financing.
In some cases, these programs even make it possible to qualify for an interest-free loan, easing the financial burden during critical repayment periods.
Common government-backed loans include:
By using these programs, borrowers may be able to access lower interest rates while supporting long-term financial health.
Borrowers need to account for APR and interest rates when comparing borrowing options to get a full view of all costs. Consider the following when assessing options and evaluating APR and interest rate:
It’s key to evaluate all factors before applying for or agreeing to credit and borrowing terms. Knowing the difference between APR vs. interest rate may help borrowers better evaluate offers and potentially make more informed decisions. Plus, this financial knowledge can help ensure users only borrow as much as they need and spend within their means.
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