Despite what some well-meaning people may tell you, there really is a difference between an interest rate vs APR (annual percentage rate). Understanding this difference is important. You don’t want to make any mistakes when calculating your loan costs.
An interest rate is essentially the cost of borrowing money for a particular length of time. It refers to the fee that a lender charges you on the borrowed capital. It is usually calculated as a fixed percentage of the principal amount. This rate is exclusive of any origination fees. Keep in mind, there could be other charges that the lender charges at the time of taking the loan. Additionally, fixed and variable interest rates exist. Federal student loans typically offer a fixed interest rate, which means your interest rate does not change over the loan’s lifetime. Private student loan lenders offer variable (as well as fixed) interest rates. A variable interest rate changes over your loan’s lifetime, and can be lower or higher than your original interest rate.
APR also refers to the total cost of borrowing but the difference is it is expressed as an annual rate and takes into account all the charges and fees that the borrower pays at the time of taking out the loan, including origination, settlement, and closing fees if any.
It is useful for making more accurate comparisons between different loans as the calculation is done while factoring in the total cost of borrowing. The interest rate helps you calculate how much you will pay on the money you borrow. However, it is not an effective tool for comparing different loans. It does not factor in the miscellaneous fees, which in fact adds to the total cost of the loan.
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