APR vs interest rate: why are they different?

The short answer

The two numbers answer different questions. The interest rate tells you how much interest is charged on the balance. The APR tells you roughly what the whole loan costs per year once certain extra charges are included.

The US Consumer Financial Protection Bureau (CFPB) puts it this way in its mortgage guidance: the interest rate is the cost you pay each year to borrow the money, shown as a percentage, and it does not include fees or other charges. The APR is a broader measure that reflects the interest rate plus points, mortgage broker fees and other charges you pay to get the loan. Because of that, the APR is usually higher than the rate.

If a lender shows you 6.5% as the rate and 6.8% as the APR, the 0.3 point gap is the effect of the upfront costs being spread across the life of the loan. If the two numbers are identical, the loan probably has no included fees.

What the law says APR is

In the US, APR comes from the Truth in Lending Act and its rule, Regulation Z. Section 1026.22 defines it as a measure of the cost of credit, expressed as a yearly rate. It links the timing and size of the money you receive to the timing and size of your payments, and it can be worked out by either the actuarial method or the US Rule method.

Regulation Z also allows a small tolerance. For regular transactions, a disclosed APR is treated as accurate if it is within one eighth of one percentage point above or below the true figure. So two lenders can show APRs that differ in the third decimal for reasons of rounding alone.

Which charges are included depends on the loan type. On a closed-end loan such as a mortgage or personal loan, upfront finance charges like origination fees and discount points generally count. Costs that are not part of borrowing itself, such as a late fee you may or may not incur, do not. Always read the fee list in the disclosure instead of assuming.

APR rules differ by country. The UK, EU, Canada, Australia and India each have their own definitions and, in some places, call the figure something else (for example, effective interest rate or comparison rate). The example below follows the US idea, but check your own regulator if you borrow elsewhere.

A worked example with real numbers

Say you need to borrow 10,000 over 36 months and have two offers. Figures are illustrative.

Offer B has the lower rate and the lower payment, yet it costs about 316 more in total. The APR shows that: with the 400 fee taken out of what you actually receive (you get 9,600 but repay as if you had 10,000), the effective yearly cost is roughly 11.3%, well above A.

The same fee on a longer loan would matter less. A 400 fee spread over 10 years pushes the APR up by a smaller amount than over 3 years, which is why APR is most useful when the terms are the same.

Credit cards, mortgages and personal loans

Credit cards. For a card, the APR is the interest rate. Card issuers usually turn it into a daily periodic rate by dividing by 365 or 360 and apply it to your daily or average daily balance, as the CFPB explains. Annual fees and late fees are separate and not rolled into that number. Paying the statement balance in full during the grace period typically means no interest at all, whatever the APR.

Mortgages. The APR includes points and lender fees, so it is the better number for comparing lenders on a fixed-rate loan. For adjustable-rate mortgages the CFPB notes that the APR does not reflect the maximum rate the loan can reach, so comparing a fixed loan with an adjustable one on APR alone can mislead. The CFPB also points out that a home equity line of credit APR does not include fees the way a closed-end loan APR does, so the two are not directly comparable.

Personal and car loans. The APR helps you see the effect of origination fees. A loan advertised as low rate with a large fee can have a higher APR than a plain loan with a slightly higher rate.

To see how the rate drives the payment itself, run your numbers in the Loan calculator. For a home loan, the Mortgage calculator adds tax and insurance, which APR does not cover. There is more on what goes into that payment in how your monthly mortgage payment is worked out.

When APR can mislead you

• You will repay early. APR assumes you keep the loan to the end. If you refinance or sell after three years on a 30-year mortgage, upfront fees are spread over fewer months than the APR assumes, so a loan with high fees costs more per year than its APR suggests.
• Different terms. A 15-year and a 30-year loan are not comparable on APR alone. Compare like for like.
• Variable rates. APR on an adjustable loan rests on assumptions about future rates that may not hold.
• Costs left out. Property tax, homeowners insurance and some third-party fees are not part of APR.

None of this makes APR useless. It is the best single number for comparing similar loans. It is just not the only number.

How to compare two offers properly

1. Ask for the same amount and the same term from each lender.
2. Write down the rate, the APR, every upfront fee and the monthly payment.
3. Multiply the monthly payment by the number of months and add upfront fees you pay out of pocket. That is the total you will hand over.
4. Check whether there is a prepayment penalty and how extra payments are applied. See how extra payments shorten a loan.
5. Pick the lower total cost that you can afford monthly, not just the lower rate.

The Loan comparison tool puts two offers side by side, with upfront fees, monthly payment and total cash paid. It runs in your browser and gives estimates; your lender's official disclosure is what counts. For a deeper look at how interest and principal split each month, read what amortization is.

Quick checklist before you sign

• Is the rate fixed or variable?
• Which fees are included in the APR, and which are charged on top?
• Are the amount and term identical across the offers you compare?
• How long will you realistically keep the loan?
• What is the total you will repay, and is any penalty charged for paying early?

Frequently asked questions

Why is APR higher than the interest rate?

APR includes certain fees and charges, such as points or origination fees, spread over the life of the loan, while the interest rate covers interest only. The extra cost raises the yearly percentage.

Can APR be lower than the interest rate?

Usually not on a standard loan. Fees only add cost, so APR is the same as or higher than the rate. Unusual cases such as lender credits can change how the figures are shown, so check the disclosure.

Which should I compare, APR or interest rate?

Compare APRs for loans of the same type and term, then also look at the monthly payment and total cost. The rate alone ignores fees; APR alone ignores how long you keep the loan.

Is the APR the same as the interest rate on a credit card?

Yes, on a credit card the APR is the rate used to calculate interest, usually applied daily. Annual and late fees are separate charges.