Difference Between Interest Rate vs Annual Percentage Rate
The percentage of principal charged by a lender for the use of its capital is commonly referred to as interest rates. When it comes to lending money anyone can give money and charge interest like banks, non-banking financial companies or sometimes even individuals. The amount of money lent is known as the principal, and banks pay you the interest rate on deposits which they are borrowing from you.
For example, let’s say that a bank has accepted a deposit from a depositor at a 6% interest rate, now in order to make profits banks will charge the borrowers of money a higher interest rate, maybe 8%, with which the bank is expected to make a profit or spread of 2%. Due to the increasing competition to get more depositors and borrowers, all the banks keep their interest rates in a narrow range to each other.
Banks levy interest rates to the total unpaid amount of the loan or your credit card balance. It becomes important to be aware of the prevailing interest rates on your money and it is the only way to know your outstanding debt. At least the interesting part should be paid out of the loan outstanding else the debt will increase even after you make payments.
The annual percentage rate includes any fees a bank may charge and allows you to compare the cost of different borrowing options. Because the bank calculates them as a percentage point of the total, these one-time fees are called points.
Head To Head Comparison Between Interest Rate vs Annual Percentage Rate (Infographics)
Below is the top 5 difference between Interest Rate vs Annual Percentage Rate
Key Differences between Interest Rate vs Annual Percentage Rate
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- Interest rates are the cost of borrowing the principal loan amount whereas APR reflects the additional points like broker fees and charges along with the interest rate that one pays to get the loan.
- The interest rate calculates what the monthly payment i.e. the EMI’s will be while the annual percentage rate calculates the total cost of the loan which can help consumers to compare loans before going ahead with one.
- If the priority is to get the lowest monthly installments then one should look at the interest rates but if the total amount of the loan is a concern then they should use APR as their metric.
- In terms of time horizon the longer the time of stay is, it becomes more likely to take a loan with a low APR as you will end up paying the lowest amount for the house. However, if the tenure of the stay is not long, it does not make sense to pay upfront fees, and instead one should get a higher APR as the total costs will be less over the first years.
- While using APR you should also factor in the break-even point.
Interest Rate vs Annual Percentage Rate Comparison Table
Below is the 5 topmost comparison between Interest Rate vs Annual Percentage Rate
| Basis of Comparison | Interest Rate | Annual Percentage Rate |
| Related to | Cost of borrowing | Total Costs of the loan |
| Meaning | The interest rates are always expressed as a percentage and are used to calculate what the actual monthly payment on the loan or the EMI will be until the term of the loan. | Annual percentage rates, on the other hand, provides the complete picture of the principal amount in question which reflects the total costs of the loan. |
| Calculation | Simple interest rate formula of A= P (1+rt) where P is the principal, at an interest rate r for the time period t, which will give the final investment value A. | The calculation is in percentage by dividing the finance charge by the loan amount and multiplying by 365 days. The result is then divided by the term of the loan and multiplied by 100. |
| Impact | Interest rates impact the outstanding debt amount of your loan amount. | The lower the annual percentage rate the lower the payments will be on the loan amount. |
| Preference | The preference for interest rates is high. | The preference for annual percentage is comparatively higher for borrowers but lower for lenders. |
Conclusion
Many borrowers are not aware of the fact that both interest rates vs annual percentage rates calculate two different costs of a home loan. The difference between interest rates vs annual percentage rates is very important as one can end up paying thousands of dollars more for a mortgage. As it helps you identify if it is better to get a lower rate with high fees or a higher rate with low fees. APR is a more detailed measure of the cost of borrowing as it includes the interest rates along with other charges.
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