Student Loan APR vs. Interest Rate: 5 Essential FAQs
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Pop quiz: What’s the difference between student loan APR and student loan interest rate?
If you don’t know the answer, that’s completely understandable. It’s not information you need every day, but it will come in handy when applying for or refinancing student loans. Both terms impact how much money you’ll spend on total interest, so they should factor into your decision when comparing loans and lenders.
It’s hard to weigh your options when some student loans display an interest rate, while others state an APR. So how do you know which loan is actually giving you the better rate? We’ve got the answers.
What do I need to know about student loan interest rate? The interest rate represents the amount your lender is charging you to borrow money. It’s expressed as a percentage of your principal and doesn’t reflect any fees or other charges that might be connected to your loan.
What is student loan APR, and how is it different from interest rate? APR, or annual percentage rate, represents a more comprehensive view of what you’re being charged—meaning it does include additional loan fees, if there are any. Because of that, a loan’s APR may be higher than its interest rate.
What additional fees/charges might be included in student loan APR? For student loans, the most common fee is the loan origination fee—an upfront fee most lenders charge for processing your loan application. The fee can vary widely from one lender to the next, and some loans may not even have one. SoFi, for example, charges no origination fees on student loan refinancing.
Another factor included in the APR is the time the loan spends in forbearance, when payments are on hold but interest is still accruing. When payments resume, that accrued interest is capitalized (added to the loan’s principal), which means the amount spent on interest increases, so your APR increases, too. Since it’s unknown if and when you might put your loan in forbearance, a new loan’s APR won’t typically reflect this cost. Just remember that if you use the forbearance option, it will likely affect your APR on the back end.
If a loan’s interest rate and APR are the same, does that mean there are no hidden fees? Not necessarily. Lenders handle origination fees in different ways, and that has a bearing on the APR. For example, for federal student loans, the origination fee is deducted from your loan disbursement up front, which keeps the fee out of the APR calculation. Private lenders, on the other hand, commonly add the origination fee to the loan amount and “finance” it, which means it is included in the APR.
When I’m shopping for a loan, should I look at interest rate or APR—or both? The benefit of the APR is that it can give you a more apples-to-apples comparison of loan costs. If you just compare straight interest rates, you could miss the big picture in terms of the total cost of the loan, and sometimes those additional fees can make a big impact.
However, even the APR doesn’t always tell the whole story. As mentioned above, the APR on a federal loan doesn’t include the origination fee, which, in some cases, is pretty significant. For example, the current interest rate on a Direct PLUS loan is 6.31%, but the loan origination fee is a hefty 4.276%. That can make it a more expensive option than a private loan with a lower interest rate and/or a lower origination fee.
What’s the takeaway? The lesson here is to ask the right questions when considering a new student loan or refinancing an existing student loan. Find out the student loan APR and the interest rate, and then check with the lender to see if there are fees or charges that may not be readily apparent.
And remember, cost is only one factor in the loan consideration process. You’ll also want to look at the potential benefits that come with the loan. For example, if you’re going to grad school to get a teaching degree or work toward a career in public service, you might be okay with paying a premium for a federal PLUS loan, because you know you’ll take advantage of federal loan benefits, such as a government forgiveness program. If that’s not the case, your priority is keeping costs low, so going through a private lender might make more sense financially.