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 a 澳洲幸运5开奖号码历史查询:line of credit, it is important to understand the difference between the advertised 澳洲幸运5开奖号码历史查询:interest rate and the 澳洲幸运5开奖号码历史查询:annual percentage rate (APR), which includes any additional costs or fees.

Put simply, a loan’s interest rate is what you pay to the lender for borrowing money. The APR is a measure of the interest rate plus the other fees charged with many types of loans, or the effective rate of interest. Both are expressed as a percentage.

Interest Rate

The advertised rate, or nominal interest rate, is used when calculating the 澳洲幸运5开奖号码历史查询: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 expe🤪nse would amount to $12,000, or $1,000 a month through the year.

Interest rates can be influenced by the 澳洲幸运5开奖号码历史查询:federal funds rate set by the 澳洲幸运5开奖号码历史查询:Federal Reserve, also known as the Fed. In this context, the federal funds rate is the rate at which banks lend reserve balances to other banks overnight. For example, during an economic 澳洲幸运5开奖号码历史查询:recession, the Fed typically will slash the fede🌳ral funds rate to encourage co𓆉nsumers to spend money.

During periods of strong economic growth, the opposite will happen: The Federal Reserve will typica✃lly raise interest rates over time to encourage more savings, less spending, and t♔o 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 澳洲幸运5开奖号码历史查询:Great Recession of 2008, rates were gradually decreased seven times to adjust to market conditions. While not the only determinant of mortgageꦕ or other interest rate🅰s, the fed funds rate does have a big influence, reflecting larger market conditions.

APR

The APR, however, is the more effective rate to consider when comparing loans. The APR includes not only the interest expense on the loan but also all fees and other costs involved in procuring the loan. These fees can include broker fees, closing costs, rebates, and 澳洲幸运5开奖号码历史查询:discount points. These are often expressed as a percentage.

The APR should always be greater than or equal to the nominal interest rate, except in the case of a specialized deal where a lender is offering a rebate on a portion of your interest expense.

The federal 澳洲幸运5开奖号码历史查询:Truth in Lending Act requires that every consumer loan agreement provide the APR along with the nominal interest rate to disclose a loan's costs.

Returning to the example above, consider the fact that your home purchase also requires 澳洲幸运5开奖号码历史查询:closing costs, 澳洲幸运5开奖号码历史查询:mortgage insurance, and loan 澳洲幸运5开奖号码历史查询:origination fees in the amount of $5,000. To determine your mortgage loan’s APR, these fees are added to the original loan amount to create a new loan amount of $205,000. The 6% interest rate is then used to calculate a new annual payment of $12,300. To 澳洲幸运5开奖号码历史查询:calculate the APR, 🦩simply divide the annual payment of $12,300 by the original loan amount of $200,000🍸 to get 6.15%.

The scenario most confusing to borrowers is when two lenders offer the same nominal rate and monthly payments but different APRs. In a case like this, the lender with the lower APR is requiring fewer upfront fee🐽s and offering a better deal.

The use of the APR comes with a few caveats, however. Because the lender servicing costs included in the APR are spread out across the life of the loan, sometimes as long as 30 years, refinancing or selling your home may make your mortgage more expensive than originally suggested by the APR. Another limitation is the APR’s lack of effectiveness at capturing the true costs of an 澳洲幸运5开奖号码历史查询:adjustable-rate mortgage (ARM), as it is impossible to predict the future direction of inte♍rest 🍨rates.

Interest Rate vs. APR

Both the interest rate and the APR 🏅on a loan reflect the cost to borrow money from a lender for a specified period of time. However, they differ in how they are calculated, what they represent, and how much control a borrower has over each.

In addition, there are strategies to consider when entering into agreements. Although a buyer may be tempted to jump at the lowest rate, this may not always be the most advantageous. For example, consider a 澳洲幸运5开奖号码历史查询:homebuyer deciding wheth♋er to minimize their interest rate or minimize their APR.

By pursuing the lowest interest rate, the🍷 borrower may secure the lowest monthly payments. However, imagine a situation where a lender can choose between one loan charging 5% and one loan charging 4% with two discount points (about 2%). In this case, a higher interest rate may be favorable.

The Bottom Line

While the interest rate determines the cost of borrowing money, the 澳洲幸运5开奖号码历史查询:annual percentage rate (APR) is a more accurate picture of total borrowing cost because it takes into consideration other expenses associated with procuring a loan, particularly a mortgage. When determining which loan provider to borrow money from, ﷽it is crucial to pay attention to the APR, meaning the real cost of financing.