Understanding the Difference Between Interest Rates and APR
Wait… what’s APR? In short: Annual Percentage Rate – isn’t that interest rate? In this article, we explain the difference between interest rates and APR and go over a few of the basics that any borrower (or potential borrower) should know.
Just like all industries, finance has specific terms and words that can be tough for newcomers to understand – for example: Interest rates and APR. Not to mention, people actually in the industry who struggle to keep up. Most people easily get confused and scared away when hearing terms they aren’t familiar with. Read on to not be one.
Interest rates and APR in a nutshell…
This percentage represents the ‘price’ of a loan. Remember that a loan is a ‘financial product’, and just like all products, sellers need to make money (profit) to stay in business. Think of interest as the ‘markup’ like a supermarket adds onto things they sell.
It’s easy to focus too much on interest rates. When they’re advertised, they only state the percentage you’ll pay for borrowing the money – the price of the loan. Interest rates do NOT include things like:
Application Fee: this is what you pay for the lender’s time to organise the loan. Prepare documents, analyse data and check documents for example.
PPSR: (Personal Property Security Register). This is an official document common for car loans that must be paid for. It shows information such as if the vehicle has been stolen, written off or still has money owing on it.
Origination Fee: This fee is for a broker or third party.
Risk Fee: An additional fee from a lender if the loan is particularly risky.
Monthly Fee: Like an account keeping fee, similar to what banks may charge you each month for your bank account.
APR – Annual Percentage Rate
You may have seen ‘comparison rates’ when looking at loans, an APR is pretty much the same. Basically, the APR (or comparison rate) takes all the fees mentioned above into account. It includes not only the interest rate but also the fees and costs of actually setting up the loan. The APR, depending on the financial institution, attempts to take the calculations many steps further to show you a more accurate picture. To do this, they take other things into account too as well as those fees:
Honeymoon / Introductory Rate: this is when a lender offers a reduced rate for a short period of time to make loans look more attractive. A discounted interest rate for the first year, for example.
APRs and comparison rates don’t take into account government grants. For example, the First Home Owners grant offered in Australia. There are a number of other government and tax rebates that may apply to your loan too so it’s best to do your homework.
How are APRs calculated?
With home loans, they are based on a $150,000 loan. Since most home loans are more than $150,000, APRs are used as a rough guide rather than a concrete contract to go by.
Other loans, like car loans, of course are far less than home loans and can differ from your specific loan so make sure you read the fine print. For example, a car loan APR / comparison rate may be based on a 5 year term but you may be looking at 6 years. Therefore, the monthly fee (mentioned above) will show 12 payments less than your loan.
***If your monthly fee is $10 – and some are more – that’s $840 over a 7-year term!
Car loan comparison rates are usually based on $30k over 5 years. As we’ve discussed, you should always use them as a guide rather than fact.
Lenders in Australia must legally show comparison rates to show consumers the ‘true’, or close to true, costs of a loan.
Here is table that shows Interest rates and APR for car loan rates in Australia:
|Lender||Interest Rate||APR / Comparison Rate|
As you can see, the APR / Comparison rate is higher as it adds the other fees and costs onto the interest rate. The interest rate on the other hand, is just the interest rate.
Interest rates and APR don’t need to be confusing. While the interest rate or ‘price’ of the loan is an important factor that we all look at, the comparison rate is a more realistic picture. When selecting a loan and lender, it’s crucial to look at all the numbers and read the fine print. Your mate might be bragging about his or her super low interest rate but is the lender making up for it with extra fees?
So how can you compare rates that suit you?
A broker. Brokers are financial experts who deal with rates and loans all day. They can find, compare and recommend options tailored to your requirements – all with no obligations and without affecting your credit file.