APR vs Interest Rate

The interest rate is what the balance accrues at, and it is the number that produces the monthly payment. Nothing else does.

The APR is a comparison figure. It expresses the rate plus certain fees as a single annualised percentage, so that a low rate carrying a large origination fee can be compared against a higher rate with none.

An origination fee deducted from the loan proceeds means you receive less than you borrowed and pay interest on the full amount. That is economically identical to a higher rate on a smaller loan.

The APR calculation makes that explicit by solving for the rate that would produce the same payments on the net amount actually received. It is the cleanest way to compare offers that price the same loan differently.

A fee is spread across the life of the loan. On a thirty-year mortgage a two thousand dollar fee adds very little to the APR; on a two-year personal loan the same fee adds a great deal.

This is also why APR flatters long loans. A thirty-year loan with a large fee can show a lower APR than a fifteen-year loan with none, while costing far more in total interest.

The calculation assumes the loan is held to term. Most mortgages are not - they are refinanced or repaid when the property is sold - and a borrower who leaves after five years has paid the full fee across a much shorter period than the APR assumed.

Which fees are included is also defined by regulation and is not the same everywhere. Two lenders in different jurisdictions, or quoting different products, may include different things in the same-named figure.

On an adjustable-rate loan the APR has to assume something about future rates, usually that the current index persists. That assumption is not a forecast and is unlikely to be correct.

For variable products, the initial rate, the adjustment schedule, the caps and the index matter more than a single APR figure that depends on an assumption nobody believes.

When two offers have the same term and the same type, compare APRs. When the terms differ, compare total cost and monthly payment separately, because a single figure cannot express both.

And when the holding period is short - which it usually is - compare the total cost over the period you actually expect to keep the loan rather than over its full term.