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Interest Rate vs. APR Meaning: Knowing the Difference

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Interest Rate vs. APR Meaning: Knowing the Difference

Interest rates and APR are two frequently conflated terms that refer to similar concepts but have subtle differences when it comes to calculation. When evaluating the cost of a loan or line of credit, it is important to understand the difference between the advertised interest rate and the annual percentage rate (APR), which includes any additional costs or fees.

Key Takeaways

  • The interest rate is the cost of borrowing the principal.
  • The APR is almost always higher than the interest rate, including other costs associated with borrowing the money.
  • The federal Truth in Lending Act requires that every consumer loan agreement list the APR along with the nominal interest rate. ? ?
  • Lenders must follow the same rules to ensure the accuracy of the APR.

Interest Rate

The advertised rate, or nominal interest rate, is used when calculating the interest expense on your loan. For example, if you were considering a mortgage loan for $200,000 with a 6% interest rate, your annual interest expense would amount to $12,000, or a monthly payment of $1,000.

Interest rates can be influenced by the federal funds rate set by the Federal Reserve, also known as the Fed. In this context, online payday loans South Carolina the federal funds rate is the rate at which banks lend reserve balances to other banks overnight. For example, during an economic recession, the Fed will typically slash the federal funds rate to encourage consumers to spend money. ? ?

During periods of strong economic growth, the opposite will happen: the Federal Reserve will typically raise interest rates over time to encourage more savings and balance out cash flow.

In the past few years, the Fed changed interest rates relatively rarely, anywhere from one to four times a year. However, back in the recession of 2008, rates were gradually decreased seven times to adjust to market conditions. ? ? While not determinant of mortgage or other interest rates, it does have a big influence reflecting larger market conditions. Read more