The interest rate is the price of borrowing the money. The annual percentage rate, or APR, is that price plus most of the upfront fees, expressed as one yearly percentage. When two loan offers have different fees, the APR is usually the better number to compare, and the offer with the lower interest rate can easily be the more expensive one.
That’s the rule. The rest of this article is about the details that make it true, and the specific cases where even APR points you in the wrong direction.
What goes into each number
The interest rate determines your monthly payment. A $10,000 loan at 9% over 36 months has the same payment whether the lender charges zero fees or $1,000 in fees.
APR is a disclosure figure required by the federal Truth in Lending Act. It takes the finance charges you pay to get the loan, such as origination fees, discount points and certain mortgage closing costs, and recalculates the rate as if those costs had been spread over the life of the loan. The CFPB’s explanation is a good plain-language reference.
Not every cost is included. For mortgages, things like appraisal fees, title insurance and credit report fees are generally left out of the APR calculation. Late fees and prepayment penalties aren’t in it either, because they depend on what you do later.
A lower rate that costs more
Take two hypothetical $10,000 personal loan offers, both for 36 months:
- Loan A: 9% interest rate, 6% origination fee deducted from the proceeds. You receive $9,400. Payment: about $318 a month.
- Loan B: 11% interest rate, no fee. You receive the full $10,000. Payment: about $327 a month.
Loan A looks cheaper. The payment is lower and the rate is two points lower. But you pay back about $11,448 for $9,400 of usable money, a cost of roughly $2,048. Loan B returns about $11,786 for $10,000, a cost of roughly $1,786. Loan A’s APR works out to about 13.3%, well above Loan B’s 11%.
The gap widens if you repay early. Say you pay off both loans after 12 months. Loan A would have cost about $1,377, Loan B about $953, because Loan A’s fee was charged in full on day one and never shrinks. More on that in our piece on origination fees.
When APR itself misleads you
APR assumes you keep the loan for its full term. Upfront costs get spread across every year of the loan. If you don’t keep the loan that long, the fees were spread too thin on paper and the real cost per year was higher.
This matters most with mortgages, where few borrowers keep the same loan for 30 years. Consider a hypothetical $300,000, 30-year mortgage with two pricing options:
- Option 1: 6.25% with one discount point ($3,000 paid at closing). Payment about $1,847. APR roughly 6.35%, ignoring other fees.
- Option 2: 6.5% with no points. Payment about $1,896. APR 6.5%.
Option 1 has the lower APR. It saves about $49 a month, which takes roughly five years to recover the $3,000. Hold the loan for ten years and the points option comes out several thousand dollars ahead. Sell or refinance after four years and the two are essentially tied; any earlier and the no-points loan wins. The APR can’t tell you which camp you’re in. Only your plans can.
APR also has limits with adjustable-rate loans. For an ARM, the disclosed APR is calculated using assumptions about future rates that may not hold. It gives you a reference point, not a forecast.
Credit cards use APR differently
On a credit card, the APR and the interest rate are effectively the same number, because cards don’t charge an origination fee that gets folded in. Annual fees, balance transfer fees and cash advance fees are disclosed separately. Cards also have several APRs at once: purchase, balance transfer, cash advance and penalty rates, plus any introductory rate.
That makes the card APR a more literal number than a loan APR: it’s the rate actually applied to your balance, typically calculated on a daily basis. Our explainer on how credit card interest is calculated walks through it.
Comparing offers side by side
When you have more than one quote, line them up on the same terms before deciding:
- Match the loan amount and term. A 60-month loan will show a lower payment than a 36-month loan almost every time. That says nothing about which is cheaper.
- Compare APRs first. If the terms match and you expect to keep the loan for its full life, the lower APR is usually cheaper.
- Then check the dollar amounts. Look at the total of payments and the amount you actually receive. For mortgages, the Loan Estimate shows both, along with a figure for what you’ll have paid in the first five years.
- Adjust for how long you’ll keep it. If you’ll likely repay early or refinance, favor lower upfront costs even at a slightly higher rate.
- Ask what’s excluded. Third-party mortgage costs, prepayment penalties and add-on products can change the picture without touching the APR.
Frequently asked questions
Can the APR ever be lower than the interest rate?
On an ordinary loan with fees, no: adding costs pushes the APR above the note rate. It can equal the rate when there are no finance charges. Promotions where a seller subsidizes the rate can create unusual disclosures, but those are exceptions.
Does a lender have to show me the APR?
Yes. Under the Truth in Lending Act and its implementing rule, Regulation Z, lenders must disclose the APR for consumer credit, and advertisements that mention certain terms must include it too.
Why did my mortgage APR change between the Loan Estimate and closing?
Fees, the rate itself or the loan terms may have changed. If the APR rises beyond a set tolerance, the lender generally must give you a corrected Closing Disclosure and a new three-business-day review period before you can close.
Is APY the same as APR?
No. APY, annual percentage yield, includes the effect of compounding and is used mostly for savings accounts and CDs. APR on loans does not reflect compounding the same way, so the two numbers aren’t directly comparable.
