APR is the acronym for the Annual Percentage Rate, which, contrary to popular belief, is not the same as the interest rate.
The APR on a loan is the cost of the money borrowed expressed as an annual rate. The cost of money borrowed includes the note rate – the loan interest rate a lender charges a borrower – along with various finance charges accrued in the process of obtaining a loan.
The APR is used as a consumer protection and education tool. It is a regulatory requirement that certain loans disclose to the borrower both the interest rate being used to calculate a monthly payment, as well as the associated APR. Regulated loans including mortgage loans, credit card debts, and all consumer loans are required to post the APR associated with each loan offering.
Again, the APR consists of the note rate on the loan, plus finance charges – so it is more than just the loan’s interest rate.
The disparity between the loan’s interest rate and its companion APR reflects the amount of finance charges associated with the selected loan. The higher the disparity between the loan contract‘s interest rate and APR, the higher the finance fees being charged.
Finance charges are characterized by fees required by the lender in order to process and fund the loan application. These fees can include such expenses as application fees, origination charges and underwriting fees, among others.
For example, a lender who quotes an interest rate of 10.00 percent over five years with an APR of 12.00 percent will have higher finance charges than a lender who quotes that same loan interest rate – but with an APR of 11.25 percent. This variance helps consumers compare loan offerings from different lenders.
|Loan A||Loan B|
|Finance Charges||Relatively More than B||Relatively Less than A|
The APR is not used to calculate a borrower’s monthly payment and is not to be confused with the loan’s note rate. The note (interest) rate is the figure used to calculate monthly payments.
Legitimate fees paid to third-party providers are usually not included in the APR calculation, even if they are required by the lender. For example, credit report and appraisal report fees are charged by some mortgage lenders. If the amounts charged actually do go to the credit bureaus and appraisers providing those reports, then those fees are usually not included in the APR.
The APR is best used when comparing similar loans from different lenders and is not effective when comparing different loan types from different lenders and loan providers. Loan payments are calculated by using the loan amount, the term of the loan, and the loan’s interest rate.
If two lenders are quoting the very same loan amount, term and note rate, the monthly payment will be the very same yet the APR may be different, reflecting more or less finance charges issued by the lender. The lender with the higher APR of the two will require higher fees to obtain the loan compared to the lender with the lower APR.
In the end, the APR provides a more accurate calculation of the true cost of a loan. In so doing, it’s a powerful tool for comparing similar loan products.
For example, mortgage lender A is offering a loan with 4.00% interest, and mortgage lender B is offering a loan with 4.75% interest.
As you shop and compare loan products, from automobile loans or credit cards to personal loans or mortgage financing, make sure that you compare both interest rates and APR. Knowing the difference can save you hundreds (sometimes thousands) of dollars over the life of your loan.
Disclaimer: NetCredit is a direct personal loan provider and does not provide financial advice, nor does it vouch for any vendor or service mentioned on our NetCredit personal finance blog or online consumer loan glossary. Always research and perform due diligence on any service provider or vendor before deciding to use them, and we recommend that you speak with a financial advisor regarding all decisions that will affect your finances.