What Is the Difference Between Interest Rate and APR?

What is the difference between interest rate and APR? The two terms are quite distinct. Interest rate is the amount of a loan that is charged as interest. If you borrow $100 at 7% interest and will pay it back after one year, you will pay back $107 (unless there are other charges in the terms and conditions). Interest itself is the amount of money you pay at a particular rate to borrow money. It is the money you pay for renting money in effect.

What Is the Difference Between Interest Rate and APR?

APR or the Annual Percentage Rate is the total cost of the money lent to you. When you borrow money it is rarely just one cost–the interest you are charged–but rather other costs as well such as bank fees. The idea behind the APR is to capture all of those costs and reduce them to a percent so that you can more easily compare one loan with another, one credit card with another. For example, if you are looking at two credit cards, one with an APR of 7.72% and the other with an APR of 8.23%, if everything else is equal, then the 7.72% card is the one to get. Things are rarely equal in the world of finance and lending. That 7.72% card, hidden in the terms and conditions, might charge you $35 penalty as a late fee, whereas the other might charge just $15. The 7.72% card might jack up your rates to 29% if you are late once. If you are getting what looks like a deal, read closely to ensure that you are.

After comparing the APRs of cards or loans, you need to go through the terms and conditions and add up all of the other potential costs that you might encounter if you want to make very sure that you are getting the best deal

That is a lot of trouble, so you should look for another term…annual percentage yield. The annual percentage yield takes a lot of other expenses into account like compound interest, which the APR does not. The way compound interest works is this, if you carry a balance on your credit card of $100 for a year and the interest rate is 12%, you might expect to pay back $112 after a year…$100 + $12 = $112. The way compound interest works is that the credit card company will actually charge you 1% interest a month. Therefore, at the end of the first month, the money you owe will be $100 + $1 = $101. At the end of the second month, the credit card company will charge you interest on $101 and so on throughout the year. On $100 compound interest is not a big deal, but on giant loans it is.

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