APR vs interest rate: which number to compare on a loan offer

The two definitions

The CFPB defines a loan interest rate as the cost you pay to the lender for borrowing money, and the APR as a measure of the interest rate plus the additional fees charged with the loan, including origination charges and other fees charged when the loan is made. [1] For mortgages, it says the APR reflects the interest rate, any points, mortgage broker fees and other charges you pay to get the loan, which is why the APR is usually higher than the interest rate. [2]

The legal definition sits in Regulation Z, which implements the Truth in Lending Act. It describes the APR as a measure of the cost of credit, expressed as a yearly rate, that relates the amount and timing of value received by the consumer to the amount and timing of payments made. [3] In plain terms: the APR is the rate that makes your payments equal the cash you actually received, after the fees.

What counts as a fee in the APR, and what does not

The APR is built from the finance charge, which Regulation Z defines as the cost of consumer credit as a dollar amount. [4] Not every charge is in it. Read the table, then check your own disclosure for charges that sit outside the APR.

Worked example: a personal loan with a withheld fee

This is the same invented loan used in the loan fine-print guide: $10,000 principal, a 12% note rate, 36 monthly payments and a 5% origination fee withheld, so you receive $9,500. The payment is $332.14 and is set by the note rate on the full $10,000. Solving for the rate at which 36 payments of $332.14 equal $9,500 gives an APR of about 15.6%.

Now compare an invented no-fee loan for the same $9,500 of cash at a 15.5% rate. Its APR is 15.5%, its payment is $331.65, and over 36 months it costs $2,439.45 above the cash received, against $2,457.15 for the fee loan. The APRs are within about a tenth of a point and the 36-month costs are within $18, which is what the APR is for: it put two differently built offers on one scale.

Lenders compute the APR under Regulation Z rules, which treat a disclosed APR as accurate within one-eighth of a percentage point for regular transactions and one-quarter point for irregular ones. [3] Small differences between your own calculation and the disclosure are normal; use the lender's disclosed APR when comparing.

Worked example: a mortgage with points

Invented loan A: $300,000 over 30 years at 6.5% with $6,000 of points and fees counted in the finance charge. The principal and interest payment is $1,896.20 and the APR comes to about 6.70%. Invented loan B: the same amount at 6.875% with no points; its payment is $1,970.79 and its APR is 6.875%.

On APR alone, loan A wins. It saves $74.58 a month, but the $6,000 takes about 80 months, close to seven years, to earn back. If you keep the loan for 30 years, A is cheaper. If you sell or refinance after five years, A's effective annual cost over those five years is about 6.99%, higher than B's 6.875%. After seven years the two are roughly even. The CFPB advises against looking at the APR alone when deciding which loan makes sense for your circumstances. [2]

When the APR misleads

• Early payoff or refinance: the APR spreads fees over the full term. Repay early and the fees count for more per year, as the five-year mortgage case shows. The same holds for the personal loan: repaid after 12 months, the invented fee loan costs about 18.3% a year.
• Different terms: a 60-month loan and a 36-month loan with the same APR do not cost the same dollars. Compare total cost and payment as well.
• Adjustable rates: the CFPB says the APR on an adjustable rate mortgage does not reflect the loan's maximum interest rate. [2]
• Lines of credit: the CFPB notes that a home equity line of credit APR does not include fees, unlike a closed-end loan APR, so the two are not comparable directly. [2]
• Excluded charges: application fees charged to everyone, late fees and some real-estate charges are outside the finance charge, so two offers can have the same APR and different closing costs. [4]
• Mixing measures: the CFPB tells borrowers to compare APRs to APRs and not APRs to interest rates. [1]

Checklist for reading an offer

All figures in this guide are invented arithmetic using monthly compounding and rounding to cents; real disclosures follow Regulation Z methods. This page is US consumer education, not personalized advice.

• Copy the note rate, the APR, the term, the payment and the amount financed from the disclosure, not the ad.
• List each up-front fee and whether it is paid, withheld from proceeds or added to the balance.
• Compare APRs only between loans of the same type and similar term.
• Write down how long you realistically expect to keep the loan, then compare dollars over that period.
• For points, divide the up-front cost by the monthly savings to find the break-even month.
• Ask which charges are not in the finance charge and add them to your own total.