Credit
The Difference Between APR And Interest Rate
An annual percentage rate folds compulsory fees and the compounding assumption into one comparable figure, which is why it usually exceeds the stated interest rate.
Two rates appear on most credit agreements and they are not the same measure. One prices the borrowing, the other exists to make different offers comparable.
The interest rate prices the money
The interest rate is the charge applied to the outstanding balance over a period, and it is the figure used to calculate what accrues each month.
Stated alone, it says nothing about fees, how often interest compounds, or how the amount borrowed is drawn down and repaid.
Two products with identical interest rates can therefore cost different amounts, which is exactly the problem a comparable measure exists to solve.
The annual rate is a standardised total cost measure
An annual percentage rate expresses the total cost of credit, including compulsory fees, as a single annualised figure calculated to a defined method.
Because it includes charges and compounding, it is normally higher than the headline interest rate, and the gap widens as fees rise relative to the amount borrowed.
The calculation method and what must be included are set by regulation, so they vary by jurisdiction and change over time.
Comparability depends on like-for-like assumptions
The measure assumes a particular pattern of drawing and repaying, which fits a fixed loan well and an open-ended revolving facility much less well.
On revolving credit the quoted figure is based on assumptions about balance and repayment that may bear little resemblance to how a given account is used.
This is why the annual figure is most useful comparing two loans of the same amount and term, and least useful comparing dissimilar products.
Optional costs sit outside the figure
Charges that are not compulsory, such as optional insurance or fees only incurred on default, are generally excluded from the calculation.
Excluding them keeps the figure comparable, but it means a product with low mandatory costs and heavy contingent charges can compare favourably while being expensive in practice.
Reading the schedule of charges alongside the rate is the only way to see those, and they are the ones that arrive when a household is already under pressure.
Advertised figures are not offers
Advertised rates are typically available to a defined proportion of successful applicants, with others receiving a higher figure after assessment.
The rate that matters is therefore the one in the personal quotation, which reflects the lender's assessment rather than its marketing.
Total amount payable, usually disclosed alongside, is often the clearer figure, since it states the cost in money rather than as a percentage.
