Interest Rate vs. APR: It Pays to Know the Difference
It’s surprising that with 364 million open credit card accounts in the U.S., many American consumers don’t understand the difference between interest rate vs. APR. Considering credit card debt continues to climb, it’s more important than ever to understand the true cost of borrowing money.
Interest Rate vs. APR
Understanding the difference between APR and interest rate starts with knowing what each term means.
What is an interest rate?
When you take out a loan or credit card, the interest rate is the percentage of your outstanding balance which you pay to borrow the money. It’s a flat percentage that can change based on a creditor’s terms, the type of loan, and repayment behavior.
What is an APR?
In the most basic sense, your APR—or annual percentage rate—is the total amount it will cost you to borrow money and measures the true cost of a loan. Beyond the simple interest rate attached to your loan or credit card, APR also includes other financing fees which are converted into a total yearly cost and broken down into a monthly expense. These can include origination fees, points fees, and closing fees among other things.
Because APR bundles the simple annual interest rate and other financing fees, knowing how it works will better help you understand the true cost of borrowing money. It’s also a useful comparison tool when determining the type of loan or credit card that makes the most sense for your financial circumstances. Janet Berry-Johnson of Credit Karma urges borrowers to consider this key question when comparing new credit card options: What is a good APR to pay?
In its Credit Card Landscape Report, WalletHub reported that average APRs on new credit card accounts in the second quarter of 2018 were at 19.05%. Meanwhile, the average APR for existing accounts was much lower at 13.08%.
Types of APR Defined
Annual percentage rates will vary depending on the type of loan and the financial institution or credit card company you’re using.
Home Mortgages and Personal Loans
Home mortgage and personal loan APRs include lender fees, closing costs and more. While these fees are unlikely to change, the simple interest rates definitely can if the fees aren’t fixed.
According to Investopedia, “A fixed APR loan has an interest rate that is guaranteed not to change during the life of the loan or credit facility. A variable APR loan has an interest rate that may change at any time.” A good APR for one person, may not be right for another. It’s important to explore different loans and the APRs associated with them so you can choose the best option for your situation.
Common fees added on top of the simple interest rate on a home mortgage loan include:
- Origination fee
- Tax service fee
- Underwriting fee
- Document preparation fee
- Wire transfer fee
- Office administration fee
- Broker’s fee
Credit Card APR
In the credit card world, the type of APR you pay will depend on how you use your card. They include:
- Introductory APR
- Balance Transfer APR
- Purchase APR
- Cash Advance APR
- Penalty APR
This short-term, low or zero percent APR is used to incentivize people to apply for a new card. These promotional rates usually last a minimum of six months and can extend for as long as 24 months. At the end of the introductory period, the APR will increase. It can also go up early due to missed or late payments.
If you plan on using one card to pay off another, you’ll likely have to pay a balance transfer fee and a special APR that will only impact the amount of money transferred.
As its name suggests, this APR applies to purchases you make with your card. When you pay off the full balance each month, you can avoid paying interest altogether.
When you use your credit card to withdraw cash from an ATM, the amount will be subject to a separate cash advance APR. This rate is usually higher than a purchase APR. As soon as you withdraw cash, you will begin paying interest on the amount.
When you fall behind on payments for 60 days or more, your credit card company will charge a penalty rate that is higher than any other form of APR. According to Experian, the average penalty APR for credit cards hovers right around 30%.
Certain fees are based on your behavior as a borrower and often are not included in your initial APR for credit cards, such as:
- Annual fee
- Balance transfer fee
- Cash advance fee
- Foreign transaction fee
- Late payment fee
- Over limit fee
- Returned payment fee
These types of fees should be outlined in your cardholder agreement so make sure to read it closely before you sign. Staying proactive about making on-time payments, not overspending, and increasing your credit score will all help keep your APR low.
What APR Should You Expect to Pay?
It’s important to keep in mind that the higher your credit score is, the lower your APR and interest rate on a loan. Before filling out an application, check out what a good APR for a personal loan is based on what you currently qualify for.
At LendingClub we like to keep it simple: your APR on a personal loan through us will include a one-time origination fee plus the interest on the loan itself. That’s it. No application fees, no prepayment fees, no surprises. Checking your rate to see what you could qualify for is fast, free, and won’t impact your credit score.*
As a borrower, you should also know that you’re protected against inaccurate and unfair credit card and billing practices under the Truth in Lending Act (TILA). Before a lender or credit card company can charge you any interest or fees, they’re required by law to disclose all actual and potential charges, fees, and rates associated with the loan.
Whatever type of loan or line of credit you need, be sure to compare your options and the true costs associated with the borrowed amount. When it comes to borrowing money, it pays to do your homework.