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What is the Difference Between Interest Rate and APR?

The interest rate and APR (Annual Percentage Rate) are two terms that are often used when discussing loans and credit. While they are closely related, there are major differences between them both –

What is the ‘Interest Rate’?

  • The interest rate is the cost of borrowing a determined amount of money, expressed as a percentage.
  • The interest rate represents the annual cost of the loan to the borrower.
  • A fixed interest rate remains the same for the duration of the loan term.
  • For adjustable-rate loans, the interest rate can change during the loan term based on market conditions such as, in the United Kingdom, changes to the Bank of England base rate.

What is the ‘APR’?

  • The APR (Annual Percentage Rate) is a broader measure of the cost of borrowing, as the APR not only includes the interest rate, but also includes fees and charges in relation to the loan.
  • The APR is almost always higher than the interest rate because it incorporates the additional fees and charges.
  • The APR gives borrowers a more comprehensive understanding of the total cost of the loan.
  • APR is used for loans that are paid in installments, such as mortgages, car loans, and personal loans.

What are the Major Differences Between Interest Rate and APR?

  • The interest rate focuses solely on the cost of borrowing the principal amount, while the APR takes into account the additional fees and costs associated with the loan.
  • The interest rate is stated as a percentage and remains fixed or adjustable based on the loan terms, while the APR is also expressed as a percentage but includes a broader range of associated costs.
  • The APR provides a more accurate representation of the total cost of the loan and is useful for comparing different loan offers.

Conclusion

When comparing loans, it is extremely important to consider both the interest rate and the APR. While the interest rate is an important measure in determining your cost of borrowing, the APR, with its inclusion of fees and charges, provides a more accurate picture of the total cost of the loan.

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