Budgeting for interest vs. APR [monthly vs. yearly budgets]

When people shop around for a loan, they may notice APRs and interest rates. While both are expressed as percentages, there are noteworthy differences between these two figures. Once people know how these numbers differ, they may be able to more easily calculate their monthly payment and the overall cost of their loan. Here’s a closer look at the difference between APRs and interest rates.

What is an interest rate?

An interest rate is applied to the loan principal, which is the amount of money a person borrows. It can be fixed and stay the same over the life of the loan or be variable and fluctuate based on market conditions. The interest rate will play a significant role in the monthly payments and is often based on a person’s credit, debt-to-income ratio, and other financial factors. Lower interest rates often lead to lower monthly payments.

What is APR?

Also known as the annual percentage rate, APR includes both the interest rate and fees of a loan. Put simply, it shows the yearly cost of borrowing and can give someone a clearer picture of how much they’ll pay overall. Lenders often include different fees in their APRs, including origination fees in many cases, sometimes ranging from 2% to 5% of the total loan amount. Unless there are no fees involved, an APR will likely be higher than an interest rate.

APR vs. interest rate

It’s no surprise that many people mix up APRs and interest rates. After all, they’re both expressed as percentages and show how much lenders charge for borrowing money. However, it’s important to understand that the interest rate is one element of APR, including various fees.

If a borrower is focused on their monthly budget, they can pay more attention to interest rates as they directly impact their monthly payments. However, if they’re working on their yearly budget, they should look closely at APRs as they explain the annual cost of borrowing.

Why are APRs and interest rates different?

As mentioned above, an APR will be likely higher than the interest rate unless the borrower gets lucky and finds a lender that doesn’t charge any fees. For this reason, most lenders advertise interest rates rather than APRs.

Regardless, people should know both before they commit to a loan. If they’re unsure of a lender’s interest rates or APRs, they should contact that lender to find out. Lenders are legally required to share this information with them.

Bottom line

Both APRs and interest rates are important to consider when borrowers compare loan options. By understanding how these figures differ, they can choose the best loan for their monthly and/or yearly budget.

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