What’s the Difference Between APR and Interest Rate?

Simply put, the interest rate is the amount the lender charges you to borrow money. The annual percentage rate, or APR, is the effective rate after all loan expenses are added.

While the terms are often used interchangeably, understanding the differences can help you make smart decisions when considering whether a personal loan, mortgage, or other loan fits into your budget.

When you understand the differences between APR and interest rate, you’ll be better prepared to compare lenders and choose the best loan to help you reach your financial goals. We’ve outlined it below to help you on your personal finance path.

If you’re interested in seeing how an APR can affect your monthly payments, you can use our personal loan calculator.

Table of contents

• What is interest rate?
• What is APR?
• Why do you need to understand both APR and interest rate? 
• How are interest rates calculated?
• How is APR calculated?
• What is a good APR on a loan?
• How can you use APR and interest rates to help you choose a loan?
• What should you keep in mind when considering a loan?

What is interest rate?

Interest rate is the percentage you pay to borrow the principal amount of your loan, typically stated as an annual rate. The interest rate applies to the life of the loan—from the day it’s borrowed to the day it’s paid off.

Interest rates come in two varieties: fixed or variable. As the name suggests, a fixed interest rate stays the same throughout the life of the loan. With a fixed-rate loan you can budget more easily as you always know how much you owe each month.

Variable interest rates can change over time. They are tied to a benchmark rate, like the prime rate. The prime rate can change periodically, depending on decisions by the Federal Reserve. Because of this, a variable-rate loan creates some uncertainty about how much you will owe on your loan in the future.

What is APR?

APR is the total cost of the loan expressed as a percentage. In addition to the interest rate, the APR includes other borrowing costs like lender fees.

The APR and interest rate may be the same for loans that don’t charge fees.

By comparison, when a loan also has origination fees or closing costs, the APR will be higher. The Truth in Lending Act (TILA) requires lenders to explain both the interest rate and APR you will pay for your mortgage or loan. Look for this information on the Loan Estimate and in the Closing Disclosure.

At Discover^® Personal Loans, for example, there are no fees at all as long as you pay on time. That means your interest rate is also your APR.

Why do you need to understand both APR and interest rate?

Borrowers tend to seek the lowest interest rate when they are shopping for a mortgage or loan. But that may not give you a full picture of the amount of money you will owe. A loan with a lower interest rate may not always be the cheapest option if there are other fees.

The stated interest rate only calculates the cost of borrowing the principal. APR is a better reflection of the total lifetime cost of the loan. It includes the interest rate plus other expenses and fees. These fees add up, so you might owe more over the life of your loan.

For example, let’s say you wanted to take out an $18,000 loan to be repaid over 60 months. If the loan has an 12.99% interest rate and does not charge any origination fees, the APR would also be 12.99%.

If the loan instead has an 12.99% interest rate but charges fees of 5% of the loan amount, those extra fees would bring the APR to 15.18%.

For example, here is a quick comparison of how a loan origination fee affects the APR when the loan amounts and interest rates are the same. In this scenario, a loan with no origination fee saves the borrower around $900 over the life of the loan.

Lender fees can significantly increase the APR of a loan.

This is why it’s important to look beyond interest rates. APR lets you make a direct comparison between loans so you can see which loan would cost you more or less over time. This way, you can see how it may fit into your budget and where you can potentially save money on your loan.

How are interest rates calculated?

Many factors are used to determine your interest rate, such as your credit history, application information, and the repayment term you select.

Lenders see credit scores as an indication of creditworthiness. The higher your score, the more likely you are to pay back your debts. You might be able to lower your interest rate by boosting your credit health—though it will take time. Here are some steps you can take:

• Pay your loans and credit card bills on time
• Don’t use too much of your available credit
• Pay down debt
• Don’t apply for multiple loans in a short period of time

If you are considering a Discover personal loan, know that we value our customers. The majority of our cardmembers receive a lower interest rate on a personal loan than non-cardmembers.

How is APR calculated?

Here are some things lenders may factor in when calculating APR:

• Interest rate: This is the amount of money you pay to borrow the loan principal.
• Finance charges: These might include prepaid finance charges, points, and other fees.
• Fees: Many lenders add fees on top of the interest rate they charge for loans. Most often, these may include loan origination fees and closing costs. Depending on the lender and the type of loan, other fees, like prepayment penalties, could apply.
• Other factors: Your APR can also be affected by your loan’s origination date and when the first payment is due.

What is a good APR on a loan?

A good APR is a combination of interest rate and fees that is below the market average. This may depend on your credit score and the lender.

If you have a strong credit history of repaying your loans, you may receive a lower interest rate. An excellent or good credit score may receive a lower rate than a score of fair or poor. A 12.99% interest rate would be considered good if the market average was 16.99%. Discover Personal Loans offers a tool that compares our APR range with several competitors.

A good APR will also be affected by any additional fees. By comparing lenders you can find the best APR for you.

How can you use APR and interest rates to help you choose a loan?

As with any financial decision, make sure to get all the facts. Remember: APR is the total cost of borrowing, and it includes up-front fees and other charges. It’s a better, more complete picture of how much a loan costs than interest rate alone.

So, always consider both interest rates and APR when you’re comparing lenders. At Discover, you can put more of your funds to work with no fees of any kind—as long as you pay on time.

What should you keep in mind when considering a loan?

Because interest rates and APR both come into play when shopping for a loan, it can be easy to confuse the two. But there are important differences.

While interest rates are part of understanding how much a mortgage or loan will cost, they don’t tell you everything. APR gives you a fuller picture of the total cost of a loan. With this information, you’re in a better position to find a loan you can afford and choose the terms that will fit within your budget.