APR vs Interest Rate

The difference at a glance

Why a mortgage APR is higher than its rate

The CFPB puts it simply: the APR reflects the interest rate, any points, mortgage broker fees and other charges you pay to get the loan. So the APR is usually higher than the interest rate.

The legal reason is the finance charge. Regulation Z defines it as the cost of consumer credit as a dollar amount, and it counts much more than interest (§ 1026.4(b)). It includes:

• Interest
• Points, loan fees, assumption fees and finder’s fees
• Service and transaction charges tied to the credit
• Premiums for insurance that protects the lender if you default, such as mortgage insurance

For a closed-end loan, the APR turns that whole finance charge into a yearly rate. It “relates the amount and timing of value received by the consumer to the amount and timing of payments made” (§ 1026.22(a)(1)). Fees you pay at closing are money you don’t get to use, so they push the APR up.

What a mortgage APR leaves out

Not every closing cost counts. For loans secured by real estate, Regulation Z leaves these out of the finance charge when they’re bona fide and reasonable in amount (§ 1026.4(c)(7)):

• Title examination, title insurance and property survey fees
• Fees for preparing the deed, mortgage and settlement documents
• Notary and credit report fees
• Appraisal and pre-closing inspection fees
• Amounts paid into escrow for taxes and insurance

So two loans with the same APR can still have different cash needed at closing. Compare the Loan Estimates in full, not just the APR line.

An example without the math

Picture two 30-year offers on the same home. Loan A has a 6.5% rate and no points. Loan B has a 6.25% rate and charges one point, a fee of 1% of the loan paid at closing.

Loan B’s payment is lower, because the payment comes from the interest rate alone. On a $300,000 loan, 6.5% means a payment of $1,896.20 and 6.25% means $1,847.15. The point doesn’t show up in either payment. You pay it once, up front.

Loan B’s APR will sit above its 6.25% rate because the point is part of the finance charge. Loan A’s APR will sit at or near 6.5%. Which loan costs less overall depends on how long you keep it. The APR spreads the point across the full schedule of payments. If you sell or refinance early, you paid the whole point but got the lower rate for fewer years.

Car loans and personal loans

The same rule applies to other closed-end loans. A personal loan with an origination fee has an APR above its interest rate, because the fee is a loan charge in the finance charge. A car loan with no fees can have an APR equal to its rate.

For payoff math on a loan you already have, use the interest rate from your loan agreement. That rate sets the payment and the interest each month. Any fees were paid at closing or added to the balance, and paying early doesn’t refund them. The early loan payoff calculator shows what extra payments save on that basis.

Credit cards: the APR is the interest rate

On a credit card, the two terms mean the same number. The CFPB’s key terms page says card interest rates are typically stated as a yearly rate, and that yearly rate is called the APR.

That’s because card APRs are calculated differently. For open-end credit, the APR shown in disclosures is the periodic rate multiplied by the number of periods in a year (§ 1026.14(b)). A card with a daily periodic rate discloses that rate times 365. Card fees aren’t folded in. Annual fees, balance transfer fees, cash advance fees and late fees are listed separately.

So on a card, compare the APR and the fees side by side. A card with a lower APR and a high annual fee can cost more than a higher-APR card if you carry only a small balance. If you pay in full every month under a grace period, the APR may cost you nothing at all. What is APR covers the five kinds of card APR, and how credit card interest works shows how the APR turns into a daily charge.

Which number to use when

• Shopping for a loan: compare APRs for loans with the same term. The APR puts fees and rate on one scale.
• Planning to pay off early or refinance soon: compare the rate and the upfront fees separately. APR assumes you keep the loan for its full term.
• Working out a payment or payoff date: use the interest rate. It’s what the lender applies to your balance.
• Comparing credit cards: the APR is the rate. Look at the fees next to it.

FAQ

What is the difference between APR and interest rate?

The interest rate is the yearly cost of the money you borrow. The APR adds certain fees, such as points, loan fees and mortgage insurance, and expresses the total as a yearly rate. That’s why a loan’s APR is usually higher. On a credit card, the APR and the interest rate are the same.

Is APR or interest rate more important?

It depends on the task. The APR is better for comparing loans with the same term, because it puts fees and rate on one scale. The interest rate sets your monthly payment and the interest charged each month, so use it for payoff math and for loans you’ll likely pay off early.

Why is my APR higher than my interest rate?

Your loan has fees that Regulation Z counts in the finance charge, such as points, origination fees, broker fees or mortgage insurance. The APR spreads those costs across the loan as a yearly rate, which lifts it above the interest rate. A loan with no such fees can have an APR equal to its rate.

Is APR the same as interest rate on a credit card?

Yes. For credit cards, the APR is the yearly interest rate the issuer charges on balances you carry. Card fees like annual fees and balance transfer fees are disclosed separately and aren’t part of the APR. The issuer divides the APR into a daily or monthly rate to charge interest.

Should I enter APR or interest rate in a payoff calculator?

For a loan, enter the interest rate from your loan agreement, because that’s the rate applied to your balance each month. For a credit card, enter the APR, since it is the interest rate. If a card has several APRs, use the one on the balance you’re paying off.