Exploring loan options with a financial institution can be a learning experience. From comparing lenders, figuring out monthly payments, and all the financial jargon in between, it’s easy to get confused or feel overwhelmed. While traditional banks tend to follow a more standardized approach, our experts at Elements are here to help you feel confident in your borrowing power!
In this article, you’ll learn the difference between interest rates and APRs (Annual Percentage Rates), and how you can use both to secure the best rate for your next car, home, or credit card.
What is an Interest Rate?
An interest rate is the price you pay to borrow money. Interest rates are shown as percentages of the base cost of your loan. Lenders use interest rates to assess risk. If your credit is in good standing, you’re more likely to qualify for a lower interest rate, meaning you’d be paying less money to borrow the funds you need.
The most common way to calculate interest is using the simple interest formula:
Simple Interest = Principal x Interest Rate x Time
You can also use your interest rate to determine your monthly payments. Use our financial calculators to see how much you’ll pay over the life of your loan.
What is APR?
The APR (Annual Percentage Rate) is the total cost, including fees, of what you are borrowing for the year. This rate includes your interest rate plus any additional charges from the lender. In the United States, we have the Truth in Lending Act (TILA), which protects borrowers by requiring lenders to disclose the APR on consumer loans. By law, lenders must provide this information before you sign any loan agreement.
Why does APR matter?
While two loans might have the same interest rate, if one loan has higher fees, its APR will be higher, and it will cost you more. If you’re applying for a loan, it’s always wise to compare both the APR and the interest rates on your offers to get the most accurate picture of your overall cost and monthly payment.
For example: Let’s say you’re borrowing $10,000 for a one-year term from a financial institution. The interest rate is 6%, and there is a $200 origination fee. That fee is calculated into the total cost of the loan, which makes the APR 16%. Even though the interest rate is only 6%, the APR is 16% because it includes the fees and considers how the loan is repaid over time.
Remember, the interest rate includes only the cost of borrowing the money, while APR is the interest rate that accounts for any other loan fees and reflects the full cost of the loan.
Getting The Best Rate
Now that you know the difference between interest rates and APRs, how can you use your newfound knowledge to your advantage? Consider the following as you’re shopping for your next better loan deal:
- Compare Both Rates: While most people shop for a low interest rate, securing a lower APR means a lower total cost for the loan, especially if you plan to keep the loan for its full term. Different lenders might offer different rates and fees, so shopping around and comparing APR and interest rates can help you find the best deal.
- Understand Loan Terms: Shorter loan terms often have lower interest rates and APRs, but higher monthly payments. Longer terms may have higher rates but lower monthly payments. If you’re planning to pay off a loan quickly, a lower interest rate with higher fees might still save you money. However, for longer-term loans, a lower APR usually means better value.
- Check Your Credit: Your credit score and history are major factors in the interest rate and APR you’re offered. Higher credit scores typically qualify for lower rates and better terms. If you’re looking for the best rate, keep a strong credit score by making timely payments and staying under your credit limits.
- Watch for Hidden Fees: Pay attention to lender fees, prepayment penalties, and other charges. Some fees are included in the APR, but others, such as late fees, are not. By carefully evaluating both interest rates and APRs, you can make informed decisions and secure the best possible rate on your loan.
Have questions or need trusted advice? Our credit union experts are always here for you. Contact Elements Financial for support in all aspects of your financial life.