Difference Between Interest Rate and APR

The Interest rate and annual percentage rate (APR) are more often than not used interchangeably. They refer to similar concepts but have some minor differences when it comes to the method of calculation.

What is the Interest Rate?

Interest rate is the annual cost of a loan expressed as a percentage to the borrower. It is simplistically defined as the cost of borrowing reflected in the loan agreement. The presumption for the most borrower is that the interest rate is the real cost of borrowing.

However, there is a catch here. The borrower in any loan shall pay other charges in addition to the annual interest to service the debt. Such costs include fees, loan insurance, discount points, loan commission, origination fees, etc. These charges are sometimes not paid upfront by deducted from the sanction loan value. The lender generally deducts these charges while disbursing the loan to the borrower, effectively reducing the available amount of the loan. The annual interest percentage is, however, levied on the original sanctioned loan amount only.

What is APR (Annual Percentage Rate)?

That’s where the borrower may use APR to calculate the real cost of borrowing considering these adjustments, costs, and actual disbursed amount. APR is the annual cost of borrowing to the borrower, including these fees and other upfront charges.

Use APR over Interest Rate?

It is essential for a borrower to know the real cost of borrowing to compare loan offers from different bankers. Some bankers may offer a relatively lower interest rate, but charging a higher upfront fee, thereby disbursing a relatively lower value. APR generally levels the different offerings from different banks and simplifies the comparison between them. The APR intends typically to provide more accurate information about what you are paying.

Don’t confuse APR as the rate of monthly payments. The interest rate shall define the monthly payment.

Interest Rate vs APR Calculations

To simplify these concepts, we can look at how real calculations look like.

For e.g. if you were looking for a loan of INR 20,00,000 at a 10% interest rate, T  tenure of 180 months, your interest expense over the loan tenure would amount to INR 18.68 lakhs or a monthly EMI payment of INR 21,492.

However, you will need to consider other charges such as insurance, processing fees, prepayment, and so on. Including all these could take your APR up to almost 10.5%, depending on the terms of your lender.

Conclusion

To conclude, APR is the more effective rate to consider at the time of selecting and comparing the loans across different bankers. The APR shall always be higher or equal to the interest rate given the method of calculating it includes more inputs than just the nominal interest rate.