What is APR? How it differs from an interest rate

APR, or annual percentage rate, is the yearly cost of borrowing money, shown as a percentage. It includes the loan’s interest rate plus certain fees you pay to get the loan, which is why it’s often higher than the interest rate alone.

Lenders must show you the APR on most consumer loans and credit cards, so you can compare offers on the same basis. What the APR captures depends on the type of credit. On a mortgage or personal loan, it folds in upfront fees. On a credit card, it’s essentially the interest rate.

Key takeaways

• The interest rate is the cost of borrowing the principal. APR adds certain required fees, such as points and origination fees, and expresses the total as a yearly rate.
• Federal law, the Truth in Lending Act and its Regulation Z, requires lenders to disclose APR on most consumer credit and sets how it’s calculated.
• On a credit card, the APR is the yearly interest rate on balances you carry. Fees such as annual fees are listed separately.
• APY is used for savings. It shows what you earn in a year once compounding is counted.

APR vs. interest rate

What the interest rate measures

The interest rate is the price you pay each year to borrow the principal, expressed as a percentage. It doesn’t reflect fees or other charges for the loan. On a fixed-rate loan, your monthly payment is based on the interest rate, the loan amount and the term.

What APR adds

APR is a broader measure. Regulation Z defines it as the cost of credit expressed as a yearly rate, based on how much you actually receive and when you make each payment. The dollar cost behind it is called the finance charge: interest plus charges you pay as a condition of getting the credit, such as discount points, origination fees and mortgage broker fees.

Because those fees are folded in, a loan’s APR is usually higher than its interest rate. If a loan has no fees that count toward the finance charge, the two numbers can be the same.

Why every lender has to show it

The Truth in Lending Act makes lenders calculate APR the same way, so one lender’s figure can be compared with another’s. The rules also set how precise it must be. For most loans, the disclosed APR must be within one-eighth of a percentage point of the exact figure, or one-quarter of a point for loans with irregular payments or advances.

How APR works on mortgages

Fees that count and fees that don’t

A mortgage APR includes the interest rate plus charges such as discount points, lender origination fees and mortgage broker fees. Some common closing costs are left out, as long as they’re reasonable in amount:

• Title examination and title insurance
• Appraisal and pre-closing inspection fees
• Credit report and notary fees
• Fees for preparing loan documents
• Money deposited into an escrow account for property taxes and insurance

So two loans with similar APRs can still need different amounts of cash at closing. Check the itemized costs, not only the rate.

A worked example

Say you borrow $300,000 on a 30-year fixed-rate mortgage at 6.5%. Your monthly principal and interest payment is about $1,896.20.

Now suppose you pay $6,000 in points and lender fees to get that rate. You still repay $300,000 at 6.5%, but you effectively received only $294,000 of credit. Spreading that $6,000 across the loan’s payments raises the APR to about 6.70%.

A second lender offers 6.75% with $2,000 in fees. Its payment is higher, about $1,945.79, and its APR works out to about 6.82%. Here the first offer has the lower APR. If the first lender charged $9,000 in fees instead, its APR would rise to about 6.80%, and the two offers would be nearly even.

Where to find the APR

After you apply for a mortgage, the lender sends a Loan Estimate. The interest rate appears on page 1 under “Loan Terms,” and the APR is on page 3 under “Comparisons.” The Closing Disclosure you receive before closing shows the final figures.

Limits of a mortgage APR

A mortgage APR assumes you keep the loan for its full term. If you sell or refinance after a few years, the upfront fees are spread over fewer payments, so your real yearly cost is higher than the APR suggests. That matters most on loans with large points.

On an adjustable-rate mortgage, the APR doesn’t reflect the highest rate the loan could reach. The Consumer Financial Protection Bureau (CFPB) also cautions against comparing a fixed-rate loan’s APR directly with an adjustable-rate loan’s, or a closed-end loan’s APR with that of a home equity line of credit, because a HELOC’s APR doesn’t include fees.

How APR works on personal and auto loans

On personal loans, the most common fee is an origination fee, which is often subtracted from the money you receive. Say you take out a $10,000 personal loan at 10% interest for three years, and a $500 origination fee comes out of the proceeds. You receive $9,500 but repay $10,000 plus interest, about $322.67 a month. The APR on that loan is about 13.56%.

Stretch the same loan to five years and the payment drops to about $212.47. The APR falls to about 12.24%, because the $500 fee is spread over more payments. But you’d repay about $12,748 in total over five years, compared with about $11,616 over three. A lower APR doesn’t always mean a lower total cost, so compare the total of payments as well as the rate.

For auto loans, check whether an advertised APR depends on a particular term, down payment or credit score, and whether any add-ons are being financed into the loan.

How APR works on credit cards

The APR is the interest rate

For credit cards, the interest rate is usually stated as a yearly rate, and that yearly rate is the APR. Unlike a mortgage APR, it doesn’t blend in fees. Annual fees, late fees and balance transfer fees are listed separately in your card agreement.

How daily interest adds up

Many issuers charge interest using a daily periodic rate: the APR divided by 365 or 360, depending on the issuer. Each day’s interest is added to the balance, which means interest compounds daily.

For example, a card with a 24% APR has a daily rate of about 0.0658% (24% ÷ 365). If you carry a $1,000 balance for 30 days with no new charges or payments, daily compounding adds about $19.92 in interest.

Several APRs on one card

A single card can carry different APRs:

• Purchase APR: applies to purchases you don’t pay off by the due date.
• Balance transfer APR: applies to debt you move from another card.
• Cash advance APR: applies when you withdraw cash. Interest on cash advances generally starts on the day of the transaction.
• Introductory APR: a temporary low rate, such as 0% on purchases or transfers. Federal rules require a promotional rate to last at least six months.
• Penalty APR: a higher rate the issuer can apply if you pay late, if your agreement allows it.

Grace periods

A grace period is the time between the end of a billing cycle and the payment due date. Card issuers aren’t required to offer one, but most do on purchases. If your card has a grace period and you pay the statement balance in full by the due date, you won’t pay interest on new purchases. Issuers must mail or deliver your bill at least 21 days before the payment is due.

If you pay only part of the balance, you lose the grace period. You’ll be charged interest on the unpaid portion and on new purchases from the date you make them.

Fixed and variable rates

A variable APR is tied to an index, often the prime rate, plus a margin set by the issuer. When the index moves, your APR moves with it. A fixed APR doesn’t follow an index, but it isn’t guaranteed never to change.

Federal rules limit when an issuer can raise your rate. In general, it must give you 45 days’ notice, and the higher rate applies only to new transactions, not the balance you already owe. The main exceptions are a variable rate that rises with its index, a promotional rate that ends as disclosed, and a minimum payment that’s more than 60 days late. In that last case, the issuer can apply a penalty rate to your existing balance after giving notice. If you then make six on-time minimum payments in a row, it must lower the rate on that balance back to what it was.

APR vs. APY

APY, or annual percentage yield, is used for savings accounts and CDs. Under the Truth in Savings Act’s Regulation DD, a bank that advertises a rate of return must state it as an APY. The APY measures the total interest you’d earn in a year based on the interest rate and how often it compounds.

The more often interest compounds, the bigger the gap between the stated rate and the APY. A savings account paying 5% interest compounded monthly has an APY of about 5.12%, so $1,000 left in the account for a year would earn about $51.16.

A loan’s APR doesn’t show compounding in the same way. A credit card with a 24% APR that compounds daily works out to an effective yearly rate of about 27.1% if the interest is never paid off.

How to compare offers using APR

APR is most useful when the offers you’re comparing are alike. Some points to keep in mind:

• Match the loan type, amount and term. A 15-year loan and a 30-year loan, or a fixed and an adjustable loan, aren’t directly comparable by APR.
• Look at the total cost. Check the total of payments and the cash due at closing, not only the APR.
• Think about how long you’ll keep the loan. Paying points to lower your rate costs more per year if you pay the loan off early.
• Check whether the rate can change. A variable rate can rise, raising both your APR and your payment.
• Know what an ad assumes. The lowest advertised APR usually goes to applicants with strong credit and income. The rate you’re offered depends on your own credit profile, the loan amount and the term.

Frequently asked questions

Is APR the same as the interest rate?

Not always. The interest rate is the cost of borrowing the principal. APR adds certain required fees, such as points and origination fees, and states the total as a yearly rate. On a credit card, the APR is the interest rate, because card fees are listed separately.

Why is my APR higher than my interest rate?

Because the APR includes fees that count toward the finance charge, such as discount points, origination fees and broker fees. Those fees raise the cost of the loan without changing the interest rate on the note.

Is a lower APR always better?

Not necessarily. A longer loan can have a lower APR but a higher total cost, and a mortgage with large upfront points can cost more than its APR suggests if you sell or refinance early. Compare the total of payments and upfront costs, too.

What’s the difference between APR and APY?

APR is the yearly cost of borrowing, used for loans and credit cards. APY is the yearly return on savings, and it includes the effect of compounding. A 5% rate compounded monthly equals an APY of about 5.12%.

Do you pay interest if you pay your credit card balance in full?

On most cards, no. If your card has a grace period and you pay the full statement balance by the due date, you won’t be charged interest on purchases. Cash advances usually start charging interest right away.

Where do you find the APR on a loan offer?

On a mortgage, the APR is on page 3 of the Loan Estimate and on the Closing Disclosure. On a credit card, it’s in the rate table in the application and card agreement, and your monthly statement shows the APRs that apply to your balance.