If you’re confused about the difference between an “interest rate” and an “APR,” you’re not alone.
But when calculated on top of a loan—especially a large loan—the two can produce very different numbers on what you owe, so it’s important that you know the difference when evaluating what a loan will cost you.
When considering an APR vs. interest rate, the first step is to know which of the two you’re looking at. Sometimes, a lender will only advertise its APR or the interest rate on a particular loan. Other times, it will provide both.
At a high level, an interest rate is the more straightforward figure. This is the cost of borrowing money, where the interest rate is expressed as a percentage of the principal. If you use an interest rate calculator , you can see how the interest rate informs your monthly interest payments when considered along with the length of the loan and the loan’s principal.
An annual percentage rate, or APR, on the other hand, is the total cost of the loan expressed in annual terms. The APR includes the interest rate and all other fees, such as origination fees, in the calculation of what you’ll owe. The APR may provide a more complete look at what a loan costs.
Below, we’ll cover the differences between interest rate and APR and spend some time exploring how APRs work on student loans, how to calculate them, and how to compare two loan APRs.
Before we dive in, we just want to be 100% real with you that this is a fairly mind-boggling topic. We’re going to try to break down these complex concepts as best we can, but please understand that this info is general in nature and does not take into account your specific objectives, financial situation, and needs; it should not be considered advice. SoFi always recommends that you speak to a professional about your unique situation.
What is an Interest Rate?
An interest rate on a loan is the rate to borrow or use an asset, expressed as a percentage of the principal. It is sometimes referred to as its nominal rate, which is the real interest rate and the inflation rate combined.
Generally, an interest rate is determined by market factors, your credit score and financial profile, and the loan’s repayment terms, amongst other things. In some instances, this isn’t the case. Some loans, such as some federal student loans, have a fixed interest rate that is not determined by your credit score or financial standing.
If a loan were to have no other fees, hidden or otherwise, the interest rate and APR could be the same number. But because most loans do have additional fees, the numbers are often different.
What is APR?
APR stands for annual percentage rate. When compared with a basic interest rate, an APR provides borrowers with a more comprehensive picture of the total costs involved in paying back a loan. Under the federal Truth in Lending Act , lenders must provide an APR on all commercial loans. This calculation includes all other fees, such as origination fees, and expresses the figure in terms of an annual percentage.
Under most circumstances, the APR will be larger than the interest rate. If it’s not, it’s generally because of some sort of rebate offered by the lender, which should be explained to you.
APR vs Interest Rate Calculation
Here’s the bottom line: The interest rate percentage and the APR number may be different if there are fees (like origination fees) associated with your loan. (Not sure what the interest rate and APR on your loan might be? You can calculate your APR with an online calculator .)
One instance in which this would be helpful is if you’re comparing two loans with very similar interest rates. By looking at the APR, you should be able to see which loan may be more cost-effective, because typically the loan with the lowest APR will be the loan with the lowest added costs.
How APR Works on Student Loans
Not all students (and graduates, for that matter) understand the true cost of their student loans. That’s because borrowers are often unaware of the additional fees charged by their student loans. Others may think that only private student loans charge fees such as origination fees, but this is also not the case.
Most all federal student loans have what are called “loan fees ” that are taken directly out of the balance of the loan before the loan is dispersed, spread evenly across each of the loan disbursements. And it’s on the borrower to pay back the entire amount of the loan, not just the amount they received at first disbursement.
The federal loan fees for the 2018-19 school year are as follows:
• Direct Subsidized Loans and Direct Unsubsidized Loans: 1.062% of the total loan amount
• Direct PLUS Loans: 4.248% of the total loan amount
As you can see, Direct PLUS Loans, loans that are utilized by parents of students and graduate students, have significantly higher loan fees than Direct Loans, whether subsidized or unsubsidized.
While interest on many other loans is actually calculated monthly or annually, interest on federal Direct Loans is calculated daily. As a result, it is slightly more difficult to do an interest rate to APR calculation on a federal student loan. Luckily, there are tools to help.
Here’s an online calculator that can help you discover the APR on a loan after you provide both the interest rate, the loan fees, and the length of the repayment term, in years (it refers to is as the “no-fee” APR, which is the same idea as the APR as we’ve discussed above).
For example, consider a $10,000 PLUS loan, which has a 7.6% rate in the 2018-19 school year. With a 4.248% loan fee that a borrower pays back over a 10-year repayment term, this student loan’s APR is nearly 8.6%. The APR is significantly higher than the interest rate that these loans advertise.
Another factor to consider is whether your student loans have a fixed or a variable rate. All federal student loans have fixed rates, and private loans could have either. Variable rates, on the other hand, fluctuate based on the market’s rate.
Comparing Private and Federal Student Loans
Both federal and private student loans have their pros and cons. In general, Direct subsidized federal student loans offer competitive rates that are typically not dependent on the borrower’s credit.
When a loan is subsidized, it means that the loan borrower is not responsible for paying the interest that accrues while the student is in school and during most deferment periods. This can make a significant difference in the amount of interest that is owed on a loan.
Additionally, federal student loans offer flexible repayment plans, including income-driven repayment options and student loan forgiveness and cancellation plans for qualifying borrowers.
Private student loans, on the other hand, typically take borrower’s credit into consideration and do not come with federal loan benefits.
To compare private and federal APRs side by side, you can play around with an APR calculator to compare private and federal loans. Comparing the APRs of private and federal loans will allow your calculations to take loan fees—in addition to the interest rates—into consideration.
Understanding Interest Costs
Being able to compare an APR to another APR certainly helps level the playing field when shopping for loans, but it’s not the only thing you’ll want to consider. You’ll also want to take into consideration the repayment period of the loan in question, because this will also have an effect on the total amount you’ll owe in interest over the life of the loan.
For example, two independent loans could have the exact same APR. But if one loan has a term of 10 years and another loan has a term of 20 years, you’ll pay more in interest on the 20-year loan even though your monthly payments may be lower. To illustrate this, let’s calculate an example; two $10,000 loans, each at a 7% interest rate, but with 10- and 20-year repayment terms.
$116.11 monthly payment
Total interest paid: $3,933
$77.53 monthly payment
Total interest paid: $8,607
As you can see, the monthly payment on the 20-year loan is lower, but you pay significantly more in interest over time. The reverse is also true; shortening the payback period should lower the amount that you pay in interest, over time, all else equal.
To understand how interest rates, loan repayment terms, and total interest charges interplay with one another, check out our student loan refinance calculator.
Refinancing Your Student Loans
If you’ve got student loans and think you’re paying too much in interest, consider looking into refinancing your student loans. When you refinance, you are paying off your existing loans with a new loan from a private lender, like SoFi. And you may qualify for more favorable loan terms, like a lower interest rate or a repayment timeline that works better for your finances.
Refinancing your loan essentially allows you to pay off your existing (federal or private) student loans with a brand-new loan. You’ll then only have to worry about one monthly payment on your refinanced loan.
SoFi student loan refinancing comes with no hidden fees, like origination fees, which can make a difference in your loan’s APR. Learn more about whether SoFi student loan refinancing is right for you.
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SoFi Student Loan Refinance
IF YOU ARE LOOKING TO REFINANCE FEDERAL STUDENT LOANS PLEASE BE AWARE OF RECENT LEGISLATIVE CHANGES THAT HAVE SUSPENDED ALL FEDERAL STUDENT LOAN PAYMENTS AND WAIVED INTEREST CHARGES ON FEDERALLY HELD LOANS UNTIL THE END OF SEPTEMBER DUE TO COVID-19. PLEASE CAREFULLY CONSIDER THESE CHANGES BEFORE REFINANCING FEDERALLY HELD LOANS WITH SOFI, SINCE IN DOING SO YOU WILL NO LONGER QUALIFY FOR THE FEDERAL LOAN PAYMENT SUSPENSION, INTEREST WAIVER, OR ANY OTHER CURRENT OR FUTURE BENEFITS APPLICABLE TO FEDERAL LOANS. CLICK HERE FOR MORE INFORMATION.
Notice: SoFi refinance loans are private loans and do not have the same repayment options that the federal loan program offers such as Income-Driven Repayment plans, including Income-Contingent Repayment or PAYE. SoFi always recommends that you consult a qualified financial advisor to discuss what is best for your unique situation.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.