What to Know About APR vs. Interest Rate
Understanding the difference between APR (Annual Percentage Rate) and interest rate is crucial when comparing loan options. Here's a simplified breakdown:
Interest Rate
Definition: The cost of borrowing the principal loan amount, expressed as a percentage. It does not include any fees or additional costs.
Purpose: Reflects the cost of borrowing money.
APR (Annual Percentage Rate)
Definition: Includes the interest rate plus additional fees and costs associated with the loan, such as broker fees and closing costs. Expressed as a percentage.
Purpose: Provides a comprehensive view of the total cost of the loan over its term.
Key Differences
Scope: The interest rate is just the cost of borrowing the principal, while APR includes all associated fees.
Comparison: APR is more useful for comparing different loan options.
Impact: A loan with a lower interest rate but high fees can have a higher APR, making it more expensive in the long run.
Practical Example
Loan A: 3.5% interest rate with minimal fees.
Loan B: 3.3% interest rate with higher fees, resulting in an APR of 3.8%. Even though Loan B has a lower interest rate, Loan A may be more affordable considering the APR.
Conclusion
When evaluating loans, consider both the interest rate and the APR. The interest rate shows the cost of borrowing, while the APR gives a complete picture of the total cost over the loan's life. This understanding can help you make a more informed decision and potentially save money.
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