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If you use a credit card or have taken a loan before, you must have heard the words “interest rate” and “APR.” Sometimes people use both these terms interchangeably. However, people familiar with finance and banking know that they are widely different terms. So, what makes the two unique? And why do people often mix them both? We’ll address both these questions in this article shortly.
Knowing the difference between the two can help you select a personal loan in your best interest. If you understand these terms clearly, you can save thousands of dollars when applying for personal loans. Before discussing the APR vs. interest rate, let’s first define each of these terms in further detail.
Here we go!
What does an interest rate entail?
Interest rates are straight forward. In terms of personal loans, the interest rate is the cost to pay off the debt. It’s the amount you pay from the time you receive the funds until the time you pay the loan back. The interest rate is measured in percentages. It is the amount that you have to pay in addition to the loan money each year until it’s paid off.
Interest rates come in various forms. Some loans, such as personal loans, offer fixed interest rates. Meanwhile, loans like credit card bills often have variable interest rates. Fixed interest rates are easier to manage because you know exactly how much you are supposed to pay throughout the period of loan repayment. You can use a debt calculator to determine the cost to pay off $10,000 in debt.
On the contrary, variable interest rates can get complicated. When you are not sure how much you will be paying in interest, it can disturb your budget and make it difficult to plan ahead. That is why most financial experts recommend getting personal loans to consolidate your debt, instead of carelessly using credit cards.
What does the Annual Percentage Rate (APR) entail?
If you’ve been contemplating the APR vs. interest rate question, then you’ll probably be wondering why do we need to have both? This question can become even more confusing when you learn about interest rates as the fee for borrowing the loan. So, what’s APR then?
Let’s break it down to make it simpler. The annual percentage rate is a more detailed account of the amount that you’ll have to pay back over the repayment period of your loans. The APR accounts for each of the following factors of each loan:
- The interest rate: The percentage of the amount of principal money that you borrow to pay as the cost of the loan.
- All associated fees: Some loans charge a loan origination fee and a closing fee. This amount is accounted for in the APR of the loan. Personal loans often don’t have an origination fee associated with them.
- Other extra charges: These include charges like a prepayment fee, late fee, and other common fees, etc.
When it comes to personal loans, understanding APR vs. interest rates is very simple. The annual percentage is the amalgamation of all the charges associated with borrowing the loan, including the interest rate.
How is the APR for personal loans calculated?
The annual percentage rate of personal loans is calculated by using the amount that you borrow, the entire length of your loan, and any additional fees associated with the personal loan (such as origination or prepayment fees). So, the APR is determined by combining all of these factors.
For example, two loans offer the same interest rate and the fixed length of repayment, but they have different origination fees and other charges. Then, your APR will be different for both these loans. When you’re given the choice of equal loans but with different APRs, you’re supposed to go with the one that offers a lower APR.
But how is an APR determined? The following factors contribute to the APR that is offered to each personal loan applicant:
- Your credit score
- Your credit history
- The amount of loan
- The length of the fixed loan term
Different lenders offer different APRs for personal loans. It mostly depends on the factors listed above. Whether you see the APR as good or bad is entirely subjective. Along with the APR, you also need to consider whether you can afford the loan. It’s crucial to accept a loan that you think you’ll be able to pay back comfortably.
Most lenders look at your credit score and history to determine whether to offer you coronavirus credit relief. It would be best to research as much as possible before accepting a loan. Apply with multiple lenders so that you have options to choose from.
How to choose the right personal loan?
When looking for a personal loan, or any other loan for that matter, it’s essential to compare numbers side by side. You have to look at the annual percentage rate and interest rate to determine the total cost of each offer. If you don’t consider these costs and only focus on the principal amount, you’ll soon find yourself drowning in payments that you can’t make.
Research the websites of your online lenders or ask questions from other lenders. You have to be clear on how much the loan will cost you and whether you’ll be able to make the monthly payments on time.
Sometimes even a seemingly insignificant difference between costs can end up saving you a significant amount in the long run.
The APR vs. interest rate can be difficult for people to understand at first. However, you must educate yourself on this before borrowing any loans. A small mistake can leave a significant mark on your credit history. That’s why it’s essential to make these decisions with full awareness.
Personal loans are an excellent form of debt, as they often offer lower interest rates and a fixed period. Make sure you compare several lenders before accepting any offer.