What Does APR Mean for Loans?

The annual percentage rate of a loan helps you make apples-to-apples comparisons of a product’s interest rate and fees.

Written by Casey Bond / October 5, 2022

Quick Bites

  • APR stands for “annual percentage rate,” which represents the yearly cost of borrowing money.
  • Lenders are required to disclose APRs so that consumers can more easily compare loan offers and understand the true costs.
  • For loans with compounding interest, annual percentage yield (APY) is an even more accurate representation of the yearly cost.

What does “APR” mean on a loan? If you’re planning to borrow money, knowing the answer to this question is crucial. A loan APR—even more so than a basic interest rate—can tell you a lot about the true cost of borrowing. Let’s take a closer look at what APR means.

Inside this article

  1. What is APR?
  2. How does APR work?
  3. How to calculate APR
  4. APR vs. APY: How they differ
  5. Frequently asked questions

What is APR?

APR (annual percentage rate) represents the yearly cost to borrow money, including fees and interest, according to Kendall Clayborne, a Certified Financial Planner at SoFi. She noted that federal consumer law requires lenders to disclose APRs.

“This is intended to give you more insight into the total cost and help you make an informed decision when comparing loans or credit cards,” she said. If you merely compared interest rates, for instance, you wouldn’t be getting a full picture of lender fees.

How does APR work?

When you borrow money, there are usually other costs involved besides the interest rate. That might include origination fees, closing costs and more. When these expenses are considered along with the principal loan balance, the true cost of the loan is higher. However, some lenders will use gimmicks to hide that true cost, so knowing the APR helps compare loan offers apples-to-apples.

Only loans that are based on simple interest, such as personal loans, auto loans and some types of mortgages, can be accurately represented by APR.[1]

How to calculate APR

Clayborne pointed out that since lenders are legally required to disclose APR, borrowers generally don’t have to calculate it themselves. Still, if you’re curious how it’s done, you can use the following formula:

(((Fees + Interest) / Principal or Loan amount / Number of days in loan term) x 365) x 100)

Here’s an example: Say you want to borrow a personal loan of $2,000 and you have 180 days to repay it. The closing costs are $50. Plus, you’ll pay a total of $120 in interest. Here’s how you’d calculate your APR:

  • Add up the total interest paid over the life of the loan and any additional fees: $50 + $120 = $170

  • Divide by the amount of the loan: $170 / $2,000 = 0.085

  • Divide by the total number of days in the loan term: 0.085 / 180 = 0.00047222

  • Multiply by 365 to get the annual rate: 0.00047222 x 365 = 0.1723603

  • Multiply by 100 to convert the annual rate into a percentage: 0.1723603 x 100% = 17.24%.

Tip

Even though APR is a standardized measure, Clayborne said it’s important to look at different factors to truly assess the cost of a loan you are considering. For example, you should consider whether the rate is fixed or variable, as well as if there is an introductory (and temporary) rate that may increase after the first year or two.

APR vs. APY: What’s the difference?

When comparing loans, you may also come across another type of rate called APY (annual percentage yield). “This is a standardized measurement that takes into consideration both the rate and frequency of interest,” Clayborne said.

Some loans and other forms of credit compound interest on a monthly or daily basis, meaning the interest is added to the principal balance and also begins to accrue interest. These loans tend to be more expensive than ones with simple interest that compounds annually, so APY gives a better picture of that overall cost.[2]

APY isn’t just important when it comes to borrowing, though. It can also refer to the amount of interest you earn on savings. “It can serve as a good measure when comparing deposit accounts, such as checking, savings, money market or certificates of deposit,” Clayborne said.

Best Online Banks of 2022

Best Online Banks of 2022

We reviewed the most popular direct banking options to find the best online checking and saving accounts for you.

Find out more

Frequently asked questions

What’s the difference between interest rate and APR?

An interest rate represents the annual cost to a borrower for a loan, expressed as a percentage. APR, on the other hand, represents that annual cost when fees are also factored in. It’s considered a more accurate picture of how much a loan will cost on a yearly basis.[3]

What is a variable APR?
What’s considered a good APR?
Article Sources
  1. Hanna Kielar, “APR: What It Is And How To Calculate It,” Quicken Loans, Jan. 24, 2022, https://www.quickenloans.com/learn/apr.
  2. Victoria Araj, “APR Vs. APY: Understanding Mortgage Rates,” Quicken Loans, Nov. 16, 2021, https://www.quickenloans.com/learn/apr-vs-apy-mortgage.
  3. “APR vs. interest rate,” Bank of America, https://www.bankofamerica.com/mortgage/learn/apr-vs-interest-rate.
  4. Ben Luthi, “What Is a Variable APR?” Experian, May 21, 2022, https://www.experian.com/blogs/ask-experian/what-is-variable-apr.

About the Author

Photo of Casey Bond

Casey Bond

Casey Bond is an award-winning writer who has been covering personal finance for more than a decade. Her work has also appeared on Yahoo!, Money.com, Fortune, MSN, Business Insider, The Motley Fool, U.S. News & World Report, Forbes, TheStreet, and more. She is a Certified Personal Finance Counselor.

Full bio

Related Content