On March 20, 2020, millions of Americans received notice that their student loans would hold a 0 percent interest rate for 60 days. The novel Covid-19 crisis moved lenders to slash their loan payment policies.
So, what did this mean for everyday borrowers? Does this sweeping change affect the APR on these borrowers’ loans? The answer is both yes and no.
Understanding how APR and interest rate are similar is key to your credit record. You should also know why they’re different and how to approach them. Here’s what you should know about both.
APR vs. Interest Rate
APR stands for annual percentage rate. Here’s where these terms may cause some confusion. The APR and interest rate both reflect the annual cost of a loan that borrowers must pay. However, the APR includes other fees.
Another key difference is that your monthly payment on loans is based on the interest rate, not your APR.
You can think of the APR as a more conclusive breakdown of your overall payments. Unlike the interest, your APR is considered the “true cost of borrowing.” The APR helps borrowers make more informed decisions on major loans than the interest rate.
According to the Federal Truth in Lending Act (TILA), every lender must disclose the APR to the borrower. As the borrower, TILA allows you to make more informed decisions about significant loans.
This largely applies to mortgages and car loans. Some personal loans may be excluded from TILA.
Is It Better to Have a Lower APR or Interest Rate?
You still might wonder whether it’s better to have a lower interest rate or a lower APR. However, this all depends on which cost you prefer to pay more towards.
Your interest rate determines your monthly payments, but your APR determines the total cost of the loan. So if you’d rather have lower monthly payments, you’d look for loans with lower interest rates.
If you have a longer loan period, a lower interest rate might be more manageable for you. Prospective homeowners typically consider this when they’re comparing mortgage loans.
With mortgages, it’s also possible to lower your interest rate through mortgage points. Borrowers can purchase these points from lenders and cut the interest by a percentage. Typically, borrowers start by paying 1 percent of the mortgage to collect 1 mortgage point.
This can ultimately lower your monthly payments, but you’ll need to determine if it’s worth the extra fees.
Types of Loans
Depending on the type of loan you get, you can have fairly high or low interest and APR rates. Your loan either be secured or unsecured, which factors into these costs.
However private and federal loans also offer vastly different interest and APR rates. Private institutions can charge borrowers at their own discretion. Meanwhile, federal institutions are more regulated and have more predictable rates.
- Home Equity Loans
- Auto Loans
- Student Loans
- Personal loans
However, federal loan APRs tend to be lower than private loans and are often lower than 10 percent. Mortgage, home equity loans, and auto loans tend to have APRs lower than 8 percent. They often even have rates lower than 5 percent.
Part of the reason is that real estate and auto loans are secured. Lenders are entitled to take away loaned physical assets such as a house or car for borrowing collateral. Unsecured loans such as student loans don’t have this physical collateral to keep borrowers paying faithfully. So, you can expect these loans to have much higher interest rates and APRs.
Personal loans can have the highest APRs, some exceeding 30 percent. Student loans tend to have lower APRs, less than 20 percent.
You can view rates for different types of loans and learn how to manage them here.
Before you compare any loans you’ll need to know which type of loan you have. Be sure to determine whether the loan includes fixed-rate or adjustable-rate interest rates and APRs. Mortgage loans often carry both fixed-rate and adjustable-rate plans.
If you have a fixed-rate mortgage, you’ll pay the same amount for the lifetime of the loan. However, an adjustable-rate mortgage (ARM) fluctuates.
Your interest rates increase over the lifespan of your loan. There are lifetime rate thresholds that control this increase.
Tips and Tricks
As a rule of thumb, remember not to compare fixed-rate APRs with ARMs.
You can review official loan estimate government documents from each lender. Since these are standard forms, you can always locate the interest rate on the first page of the form. Likewise, you can always locate the APR on the third page.
Once you locate the interest rates and APR for each lender, you’ll have a much clearer comparison. Know that even though one lender’s interest rates may be higher, they might offer a better deal if their APR is lower.
ARMs also use loan estimate forms but they don’t show the increased rate over time. Because they fluctuate, ARMs can be harder to compare to find the best deal.
In addition to using these forms, you should use an APR calculator. Be sure to factor in the span of time that each rate changes in. Some APRs can increase much higher within the first five years than another APR after the first ten.
Other fees such as credit reporting costs may not be reflected by the APR. You should ask your lender what fees are included and excluded from the APR so that you don’t have any surprise expenses. Here are the standard fees included in your APR:
- Broker fees
- Loan origination fees (loan opening fee)
- Discount points
Credit cards often have different APR applications than other types of loans. They carry APR fees based on transactions that only apply to credit cards:
- Introductory APR
- Purchase APR
- Penalty APR
- Balance Transfer APR
Lenders collect an introductory APR when borrowers first open their account. However, many lenders offer a 0 percent introductory APR for at least 12 months.
Other APR fees such as purchase and penalty APR occur from payment or credit line penalties.
If you don’t fulfill payments on time, you’ll have a purchase APR fee to pay on top of your next purchase. In addition, you may need to pay a penalty APR for making late payments.
Lastly, a balance transfer APR occurs when you move the credit balance from one card to another. Introductory APR may apply to the new card after you make the transfer.
Managing the APR and Interest Rates on Your Loans
If you need help managing multiple loans at a time, you may want to consider consolidating them.
On the other hand, it may be helpful to hire a credit advisor to help you with consolidation or simply answer your questions about APR and interest rates.
You can also find some answers right here on our site. Be sure to check out more articles to stay sharp!