The difference between APR and interest rates

Understanding starts with the basics

When you’re looking for a private student loan it can be tough to compare them—there are so many numbers and features. What you probably look at first is the loan’s interest rate. But there’s also a figure called APR with a different percentage. What do they mean, and which one gives you better information? The answer: they’re both important numbers to know, but they tell you different things.

What is an interest rate?

An interest rate is the percentage charged to borrow money from a lender. It’s what you agree to pay for the amount you’re borrowing, whether for a student loan, car loan, or mortgage. Interest rates can be fixed (the same for the life of the loan) or variable (may fluctuate over the life of the loan). For example, a 7% interest rate on a $10,000 student loan could cost you $10,700 in just one year. An interest rate doesn’t reflect any fees or other charges.

Interest rates may be presented in a range on a private lender’s website; you won’t know your actual rate until you apply.

What is an APR? 

Unlike an interest rate, the annual percentage rate (APR) includes interest plus any fees and other charges, like an application fee or origination fee (a percentage charged for processing your loan), that you’ll pay to get the loan.

For example, federal student loans charge a loan fee—1.057% for direct unsubsidized and subsidized loans disbursed on or after October 1, 2020. That percentage would be figured into the APR for those loans.

The Federal Truth in Lending Act says that the APR must be disclosed for any kind of loan you get. That means comparing APRs for different student loans you’re considering can be a good “apples-to-apples” way to evaluate them on an equal basis.

What’s the difference between an interest rate and an APR?

An interest rate is the percentage charged to borrow money. So, unlike an APR, an interest rate doesn’t consider:

• The amount of the loan
• Whether unpaid interest will be capitalized (added) to your principal balance
• Whether you make in-school payments or defer until you leave school
• How long your repayment term is (the amount of time it’ll take you to pay back your loan)

These differences are why it’s useful to consider both the interest rate and the APR when you’re comparing student loans.

Tip: A student loan calculator can be helpful for figuring out how making in-school payments can help you save on your total cost.

Graduating with less debt

While it’s important to look at a student loan’s interest rate and APR, here are some other things you can do to lower your total loan cost:

• Always start by looking for scholarships and grants: Money you don’t have to pay back is always the best way to get money for school.
• Choose an in-school repayment plan: You may be able to lower your total loan cost by paying interest or a fixed amount in school, rather than deferring all payments until later. 
• Make extra payments when you can: Even if you choose to defer in-school payments you can save money by making extra payments whenever you can—check with your lender to make sure there are no penalties for doing this. Again, this will lower the total cost of your loan.
• Take advantage of discounts: Signing up for auto debit can lower your interest rate if your lender offers that benefit.
• Avoid extra fees: Lenders may have other fees that can increase the amount you’re paying for school, like late fees and fees for returned checks or insufficient funds in your bank account. These are usually avoidable, so don’t pay more than you have to.

Knowing what an APR really means makes it easier to compare student loans on an equal basis. And while there are other loan benefits that you should consider, the APR is a good place to start.