APR Vs. Interest Rate: What’s The Difference?

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Published: Jun 16, 2022, 5:30pm

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When you apply for a home loan or any loan, the terminologies used to describe different types of interest rates may leave you perplexed. Some common questions around what an annual percentage rate (APR) means, how interest rates are calculated, are the APR and interest rates interchangeable may arise. 

In simple words, the annual percentage rate is a measure of how much money you will have to pay back in total, given your loan terms. An interest rate, on the other hand, is a measure of how much money you will have to pay back in one year given your loan terms. 

While opting for a loan, these two terms can help you understand the loan costs and also negotiate a better loan offer if necessary. Here’s how both the annual percentage rate compares to the interest rate and how it affects your home loan cost.

What is an Interest Rate?

The percentage rate a consumer pays to a lender for a specific period is known as an interest rate. The percentage may be fixed, which means it will remain constant throughout the loan term, or it may also fluctuate based on market rates. 

Each borrower repays both the initial amount borrowed (your principle) as well as any interest. However, the interest rate does not include any fees or other charges associated with the loan. The interest rate is simply what the cost of borrowing money for that specific period is. 

Let’s understand this with the help of an example, say Prateek borrows INR 80 lakh to buy a house at a 7.2% interest rate. As a result, his mortgage builds 7.2% interest per year at the beginning of the loan. That is roughly $63,000 a month, or INR 7,55,855 annually.

What is an APR?

APR is a calculation that determines how expensive a loan or credit product is; it takes into account the cost of borrowing money and other associated costs such as monthly fees and the amount of time you plan on taking to repay the loan. This is a standardized measurement that lenders use to help consumers understand the true cost of a loan. 

The APR is used for both unsecured and secured loans, like home loans, car loans, personal loans, student loans, and credit cards. The APR includes the interest rate, any upfront fees, and any other applicable charges. For example, if a borrower has a home loan with an interest rate of 7.5% and pays INR 7,000 in fees over a year, the APR would be 7.5% percent plus INR 7,000 in fees, or approximately 9%. Although the interest rate is less, the APR is higher—meaning it will take you longer to repay the entire amount.

How are Interest Rates Calculated?

Interest rates in India are complex and varied, depending on the type of loan and the lender. However, some general principles can help you understand how interest rates are calculated. The most important factor in determining interest rates is the Reserve Bank of India’s (RBI) policy rate. This is the rate at which the RBI lends to banks and is also known as the repo rate. 

Generally, interest rates on loans are higher than the RBI policy rate. This is because banks have to cover their costs, such as operating costs and risky loans, and also make a profit. For example, if the RBI policy rate is 4%, a bank may charge an interest rate of 7% on a loan.

But the most common way is by using the prime rate. The prime rate is the interest rate that banks charge their most creditworthy customers. This rate is usually very low, and it serves as a benchmark for other interest rates. If a borrower has a good credit score, they will usually be able to get a lower interest rate. This is because lenders view them as being less of a risk.

Other factors that can influence interest rates include the type of loan, the tenure of the loan, the creditworthiness of the borrower, and the prevailing market conditions. The interest rate on a loan can also vary depending on the tenure of the loan. For example, a shorter-term loan may have a higher interest rate than a longer-term loan. This is because there is more risk involved for the lender with a shorter-term loan, as the borrower may not have the ability to repay the loan in full.

How is APR Calculated?

APR is the rate charged by banks and other financial institutions on the loans they provide. It is expressed as a percentage of the loan amount and is usually calculated on an annual basis. In India, the APR is calculated by taking into account the interest rate, any fees charged by the lender, and the length of the loan. Interest is calculated by adding up each month’s interest charges and dividing by the loan amount. This gives you an average interest rate per year. Using this rate, the APR is calculated.

The APR is an important factor to consider when taking out a loan. It helps you to compare the total cost of different loans and choose the one that is best for you. For example, a loan with a lower APR may have a higher monthly payment but will cost less in the long run. Conversely, a loan with a higher APR may have a lower monthly payment but will cost more in the long run.

The APR can be lower than the interest rate if the borrower pays fees up front, which reduces the amount of interest that must be paid over the life of the loan. Also, keep in mind that the APR is just one factor to consider when comparing loans. Other factors, such as the loan amount, repayment schedule, and fees, can also impact the overall cost of the loan.

APR vs. Interest Rate

It’s a common question and one that’s important when taking out a loan. 

APR is the annual percentage rate, which includes both the interest rate and any fees charged by the lender. The interest rate is the percentage of the loan that you’ll pay in interest, while the APR also includes any fees charged by the lender. 

Generally, the interest rate is the more important number when you’re comparing loans. That’s because it’s the number that will determine your monthly payments. The APR can be helpful when you’re comparing offers from different lenders, but it’s not the most important number. 

When you’re looking at APR vs. interest rate, keep in mind that the interest rate is the number that will have the biggest impact on your monthly payments. Make sure you compare offers from different lenders and look at the interest rate before making a decision.

Which One Is More Important When Taking a Home Loan – APR or Interest Rate?

When considering a home loan, it’s important to understand the difference between APR and interest rate. APR takes into account all the costs associated with a loan, while the interest rate is just the percentage of the loan amount that you will be charged each year. Your APR will be higher than your interest rate if your loan has fees or points. It’s important to understand that APR is always higher than the interest rate. This is because the APR includes all of the fees associated with the loan, while the interest rate only includes the interest. 

So, which of the two is more important? Both APR and interest rates are important when it comes to a home loan. In most cases, the interest rate is more important. This is because it is the rate that you will be charged on the loan, and it is the rate that will affect how much you repay on the loan. However, on the other hand, APRs are a more comprehensive measure when you are looking for a home loan. This is because the APR can give you a better idea of the total cost of the loan, and also take into account other charges associated with the loan, such as points, fees, and mortgage insurance. As a result, APRs are typically higher than interest rates.

It is always suggested that you should focus on both the interest rate and the APR when you’re shopping for a loan. That way, you’ll get a good sense of the true cost of the loan. To get a better idea, it is ideal to work with a home loan advisor who can help you understand the difference and find the best loan for your needs.

Low-Interest Rates or Low APRs: Which is Better?

There is no easy answer, as it depends on your independent circumstances. If you plan on paying off your debt quickly, a lower interest rate may be better for you. On the other hand, if you can’t afford to make large payments, a lower APR may be a better option. Ultimately, you’ll need to consider your financial situation to decide which is best for you.

Bottom Line

The final word on APR vs interest rate is that they are both important factors to consider when taking out a loan. APR takes into account all of the costs associated with a loan, while the interest rate only reflects the cost of borrowing the money. It’s important to consider both when making a decision about which loan is right for you. The APR can help understand the true cost of a loan, whether it’s a mortgage, car loan, or credit card. Knowing your APR can help you budget and plan for how long it will take to pay off a loan. Similarly, the interest rate helps understand how much you’ll owe once a loan is paid off. 

Before closing on a home loan, your lender must inform you of both your interest rate and your APR. By controlling your credit score and choosing government-backed loans, you can lower your interest rate. In most cases, you do not have control over your APR since it is set by the lender. It is therefore best to compare similar loan programs with different lenders to find a lower interest rate.

Knowing the difference between interest rate and APR will help you make an informed decision when shopping for credit.

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