Two loans can advertise the same interest rate and still cost you very different amounts. The difference is almost always fees. That is why lenders in most countries are required to show a second figure alongside the rate: the APR in the US and UK, or the comparison rate in Australia.
This guide explains what each number measures, which fees go into it, how to calculate one yourself, and when you should look past it.
The interest rate is the price of the money
The interest rate, sometimes called the nominal rate or note rate, is what the lender charges you for borrowing the principal. It is the number used to calculate your regular repayment and the interest that accrues on your balance.
If you borrow $20,000 at 9% over three years, your monthly repayment is $635.99 and you pay $2,895.81 in interest over the loan. That figure is exact, but it is not the full cost, because it ignores everything else the lender charges you to set up and run the loan.
APR is the interest rate plus the cost of fees
The annual percentage rate (APR) expresses the total cost of credit, interest plus most required fees, as a single yearly rate. In the US it is required by the Truth in Lending Act, and for mortgages you will see it on your Loan Estimate next to the note rate.
The calculation works backwards. The lender takes the amount you actually receive, after upfront fees, and finds the interest rate at which your scheduled repayments (plus any regular fees) would exactly pay off that smaller amount. Because you are repaying the same money but receiving less of it, the APR is higher than the interest rate.
A rule of thumb. If the APR is close to the interest rate, the loan has few fees. A large gap means you are paying a lot to get the loan, and that cost should be part of your comparison.
Which fees are included
The exact rules vary by country and loan type, but for a US mortgage the split typically looks like this:
| Usually included in APR | Usually excluded from APR |
|---|---|
| Origination or application fees | Appraisal (valuation) fee |
| Discount points bought to lower the rate | Credit report fee |
| Mortgage broker fees | Title insurance and title search |
| Prepaid interest | Recording fees and transfer taxes |
| Mortgage insurance premiums (PMI) | Property taxes and homeowners insurance |
| Underwriting and processing fees | Late fees and other contingent charges |
For personal loans and car loans, upfront origination or establishment fees and ongoing account-keeping fees are usually included. Fees that depend on what you do later, such as late payment or early repayment charges, are generally excluded everywhere, because no one knows in advance whether you will pay them.
Worked example: how fees turn 9% into more than 11%
Take that $20,000 personal loan at 9% over three years, with a $600 origination fee taken out of the loan proceeds. You receive $19,400 but still repay $635.99 a month on the full $20,000.
Finding the APR. Search for the monthly rate at which 36 payments of $635.99 are worth exactly $19,400 today. That rate is about 0.924% a month. Multiply by 12 and the APR is 11.09%.
Now add a $10 monthly account fee. Your real outgoing is $645.99 a month, and the APR climbs to 12.18%. Your total cost of borrowing is $3,855.81, a third more than the $2,895.81 of interest alone.
The term of the loan matters too. The same $600 fee on the same 9% rate produces a very different APR depending on how long you have to spread it out:
| Loan term | Monthly repayment | APR with $600 upfront fee |
|---|---|---|
| 1 year | $1,749.03 | 14.78% |
| 2 years | $913.69 | 12.05% |
| 3 years | $635.99 | 11.09% |
| 5 years | $415.17 | 10.31% |
Upfront fees hurt most on short loans. If you are borrowing a small amount for a short time, a “low rate” loan with a big setup fee can be one of the most expensive options available. Our personal loan calculator works out this effective rate for you once you enter the fees.
Comparison rate in Australia
Australia uses the term comparison rate instead of APR. Lenders must show it whenever they advertise an interest rate on most consumer loans. It combines the interest rate with upfront and ongoing fees in a similar way to an APR.
The twist is that the comparison rate is calculated on a standard example rather than your actual loan. For home loans the standard example is $150,000 over 25 years. If you borrow $600,000, the fixed fees are spread over a much bigger balance, so the comparison rate overstates their effect for you. If you borrow a small amount, it understates them.
Comparison rates also leave out government charges such as stamp duty, and contingent fees such as break costs, late fees and redraw fees. Every advertised comparison rate carries a warning that it is true only for the example given and may not include all fees. Moneysmart has a good plain-English explanation.
APR, APRC and AER in the UK
The UK uses several related terms:
- APR applies to credit such as personal loans, car finance and credit cards. Adverts usually show a representative APR, which at least 51% of successful applicants from that advert must receive. The rest may be offered more.
- APRC (annual percentage rate of charge) is the mortgage version. It covers the whole mortgage term, including the rate you would revert to when an initial fixed or tracker deal ends.
- AER (annual equivalent rate) is used for savings, not borrowing. It shows the interest you would earn in a year if interest were paid and compounded annually, so you can compare accounts that pay monthly with those that pay yearly.
There is also a technical difference. A US APR is a simple annualized figure: the monthly rate multiplied by 12. The UK method includes compounding. On the $20,000 example above, the US-style APR is 11.09% while the UK-style APR for the same cash flows is about 11.68%. Neither is wrong. Just compare like with like.
In Canada, lenders must also disclose the APR and the total cost of borrowing before you sign, and the Government of Canada publishes guidance on reading those disclosures.
When APR misleads
APR assumes you keep the loan for its full term and that the rate never changes. Real life rarely works that way.
You will not keep the loan for the full term
Most mortgages are refinanced or paid off when the home is sold long before year 30. Upfront fees and points are calculated as if they are spread over the whole term, so a loan with heavy upfront costs can show a lower APR but cost more if you leave early.
Points vs no points on a $300,000 mortgage. Loan A is 6.0% with two discount points ($6,000). Loan B is 6.375% with no points. Repayments are $1,798.65 for A and $1,871.61 for B.
Loan A has the lower APR, about 6.19% against 6.375%, and it is cheaper over 30 years. But counting the points, interest and the balance left owing, Loan B is cheaper if you sell or refinance within about 5 years and 4 months. After three years, Loan A would have cost you about $2,600 more.
US mortgage borrowers have a helpful tool here: the “In 5 Years” figure on page 3 of the Loan Estimate shows the total you would pay in the first five years. If you expect to move or refinance, compare that number as well as the APR. The refinance calculator uses the same break-even logic.
The rate is variable or adjustable
For a variable-rate loan or an adjustable-rate mortgage (ARM), the APR is based on assumptions about future rates, typically that the index stays where it is today. If rates rise, the true cost will be higher. A low introductory rate also pulls the APR down even though you will only pay it for a short period. Our guide to fixed vs variable rates explains how to stress-test repayments instead.
Some costs sit outside the figure
APR does not capture everything. Excluded fees, insurance you are sold alongside the loan, and the cost of features such as an offset account can all change which loan is truly cheaper. On US credit cards, the APR is simply the interest rate, and annual fees are disclosed separately.
How to compare loans properly
Use APR or the comparison rate as a first filter, then check the details:
- Compare total cost over the time you expect to keep the loan, not just the full term. Add upfront fees, ongoing fees and interest for that period.
- Ask for a list of every fee, including those excluded from the APR, such as valuation, legal and discharge fees.
- Check what happens when any initial rate ends and what the loan reverts to.
- Value the features you will actually use, such as extra repayments, redraw or offset, and ignore the ones you will not.
- Run the numbers side by side. The loan comparison calculator lets you put two offers, with their fees, next to each other.
Once you have chosen, understanding how amortization works will show you where your repayments go each month. For quick definitions of APR, APRC, comparison rate and origination fee, see the financial glossary.
This guide is general information, not personal financial advice. Rules and products vary by country and lender.