What is APR?
The difference between APR and interest rate, how APR is calculated, and how to use it to compare loans and credit cards.
APR vs interest rate
When you borrow money, lenders quote two rates that are easy to confuse:
Interest rate
The percentage of the loan principal charged as interest per year. This is the "pure" cost of borrowing — it doesn't include fees.
APR (Annual Percentage Rate)
The total yearly cost of the loan expressed as a percentage — including the interest rate plus most fees (origination fees, mortgage points, closing costs). Required by US law (the Truth in Lending Act) to be disclosed on all consumer loans. APR is always ≥ the interest rate.
If a lender advertises "3.5% rate" but the APR is 3.8%, the difference (0.3%) represents fees rolled into the loan cost. APR exists to let you compare loans on equal footing regardless of how fees are structured.
How APR is calculated
The simplified APR formula adds all fees to the interest cost and divides by the loan principal and term:
APR = ((Total Interest Paid + Total Fees) / Principal / Loan Term in Years) × 100 Example: Loan: $200,000 Interest rate: 6.5% Fees: $4,000 (origination fee + points) Term: 30 years Total interest at 6.5% ≈ $255,000 Total cost = $255,000 + $4,000 = $259,000 APR ≈ ($259,000 / $200,000 / 30) × 100 ≈ 4.32% (Actual APR calculations are more complex — they account for the time value of money using IRR-style math.)
The actual APR calculation uses the Internal Rate of Return (IRR) — the discount rate that makes the present value of all payments equal to the loan amount. This is why APR and simple arithmetic don't match exactly for long-term loans.
What fees are included in APR
The specific fees included vary by loan type, but typically:
Usually included
— Origination fees and points
— Mortgage broker fees
— Closing costs the lender controls
— Prepaid interest (for mortgages)
Usually excluded
— Third-party fees (title insurance, appraisal, taxes)
— Late payment fees
— Prepayment penalties
— Optional add-ons (credit insurance)
Because lenders have discretion in what they include, two identical loans can show slightly different APRs depending on the lender's disclosure practices. APR is a better comparison tool than the interest rate alone, but it's not perfect.
APR on credit cards
Credit card APR works differently from loan APR. The key things to understand:
Daily periodic rate — credit cards calculate interest daily. APR ÷ 365 = daily rate. A 20% APR card charges 0.0548% per day on your balance.
Grace period — if you pay your full balance by the due date each month, you pay zero interest. APR only matters if you carry a balance.
Multiple APRs — most cards have different rates for purchases, cash advances, and balance transfers. Cash advances usually have a higher APR and no grace period.
Variable APR — most credit card APRs are tied to the Prime Rate and change when the Fed adjusts rates.
APR vs APY
APY (Annual Percentage Yield) is the same concept applied to savings instead of borrowing. APY accounts for compounding — earning interest on your interest. For savings accounts and CDs, look at APY. For loans and credit cards, look at APR.
APY = (1 + APR/n)^n - 1 where n = number of compounding periods per year Example: 5% APR compounded monthly APY = (1 + 0.05/12)^12 - 1 ≈ 5.12% The more frequently interest compounds, the higher the APY relative to APR.
Frequently asked questions
- Should I always choose the loan with the lowest APR?
- Usually, but not always. APR assumes you hold the loan for its full term. If you plan to sell a home or refinance within 5 years, a loan with higher upfront fees but a lower rate might have a lower APR but cost more in reality. Compare total cost over your expected holding period, not just APR.
- Why is the APR on a 15-year mortgage higher than the APR on the 30-year version?
- On a shorter loan, fixed fees (like origination costs) are spread over fewer payments, making their annual impact larger — which raises the APR. This is counterintuitive but mathematically correct. The 15-year mortgage will almost always cost less in total interest paid despite the higher APR.
- Does a 0% APR credit card offer really mean no interest?
- During the promotional period, yes — no interest accrues. But read the fine print: if you miss a payment or carry a balance after the promo period ends, some cards retroactively charge interest on the original balance. After the period ends, the standard APR (often 20–30%) applies to any remaining balance.