We see a lot of confusion around the difference between APR and interest rate, but we want to make it clear that APR is NOT the same as your monthly interest charge. We’ll break down the key differences between both and how a loan being secured vs unsecured plays a role.
What’s the Difference Between the Interest Rate and APR?
The interest rate is the cost of borrowing the principal loan amount. The APR–annual percentage rate–includes the interest and all fees/costs involved in procuring the loan. The APR is what you really want to look at when comparing loans since it gives a more holistic look at what your monthly payments will be.
The interest rate on your loan is calculated based on prevailing rates and your credit score. For those with excellent credit scores, you can expect to have favorable interest rates. These factors do not have the same impact on your APR, which is determined by the lender’s fees (this is where comparison shopping comes in handy).
APR fees include broker fees, rebates, closing costs, etc., and are often expressed as a percentage. The APR will never be lower than the nominal interest rate, but it can be equal or higher. The only exception is a special deal that includes a rebate on a part of your interest expense. Something to consider is that lenders may not include all fees in the APR. Costs like credit reporting and inspection fees are their own separate cost, though these typically aren’t very high for a personal loan. You can ask the lender outright how much the total cost will be with these additional fees.
One way to think about APR is in terms of a home purchase. The closing costs, mortgage insurance, and loan origination fees are all a part of the APR. To calculate your APR, you can divide your annual payment by the original loan amount. This will give you a percentage.
How to Prioritize
If you’re comparing two loans and one offers a lower nominal rate, that’s likely going to give you the biggest bang for your buck (since the majority of the loan amount is financed at a lower rate). BUT, when two lenders have the same nominal rate and monthly payments, you want to go with the one that has the lower APR. This means they have fewer up-front fees. One way to look at it is to think of the interest rate as monthly costs and APR as the big-picture estimate for the cost of the loan.
In the case where you’re purchasing a home and plan to stay there long-term, it makes more financial sense to take out the loan with the lowest APR. For those who only plan on staying in their home for a few years though, it might make more sense to pay fewer upfront fees in exchange for a higher rate. This is because the total cost will decrease over the next few years.
Note: The Federal Truth in Lending Act requires that consumer loan agreements list the APR along with the nominal interest rate.
Unsecured Loan vs Secured Loan Rate
Something important to note is that unsecured loans typically have higher rates than secured loans. At Helix, we offer unsecured loan personal loans that may have higher rates than say, a mortgage, because those loans are backed by collateral (less risk for the lender).
To attain a secured loan, you have to offer a personal belonging or asset as collateral. That might be your home, your vehicle, etc. In the unfortunate case where you default on your loan, the lender then has the right to take that collateral to cover their loss. For a secured personal loan, collateral might be funds from a savings account. Secured loans often have higher borrowing limits as well, which makes them a great option for larger loans.
With an unsecured loan, the lender is taking on more risk. There is no collateral required of the borrower, but, in turn, the interest rates and APR may be higher. In general, personal loans are unsecured, as well as credit cards and student loans. Defaulting on either type of loan can harm your credit score, so you really want to avoid defaulting if possible.
If you’re trying to decide between the two, there are some factors to consider. For one, a secured loan is easier to attain. This is because there’s less risk for the lender. If you have a poor credit score, you’re more likely to be approved for a secured loan vs an unsecured loan. This will allow you to rebuild your credit and open up options from there.
Benefits of an Unsecured Loan
Unsecured loan rates may be higher, but with good reason. Since the lender is taking on more risk, they need some assurance that they’ll be able to recoup their loss should you default. The nice thing about an unsecured loan is that you don’t have to worry about losing your home or car. There are consequences though; failing to make on-time payments can result in your debt becoming less and less manageable.
An unsecured loan is granted based solely on the borrower’s creditworthiness, and there are consequences when a borrower fails to pay. Your account may be sent to a collection agency, which may result in you being summoned to court or your wages garnished.
If you have additional questions about the difference between APR and interest rate or unsecured vs secured loans, feel free to contact us.