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Interest rate vs. APR: What’s the difference?

2 min read

When lenders show the interest rate and the APR, what does it mean? Here’s how to tell the difference when you compare loan offers.

When you’re shopping for a business credit card or loan, you need to understand the difference between interest rate and annual percentage rate (APR). These are two critical factors in the fine print that affect how much you’ll pay when you borrow funds.

 

What’s an interest rate?

 

When you borrow money, a lender will charge you interest on the total amount borrowed, otherwise known as the principal amount. An interest rate may be initially based on the Prime Rate or the London Interbank Offered Rate (LIBOR), plus additional percentage points determined by the lender.

 

The interest rate you’re charged may depend on several other factors, including (but not limited to):

 

  • The type of financing
  • The lender
  • Your credit risk
  • The amount you’re borrowing
  • The loan term

 

What is APR?

 

Interest rate and annual percentage rate sound quite similar but are actually different. The APR is the total annual cost of your loan above the principal that you’re repaying. The APR includes your annualized interest rate plus other costs and fees. This means the APR can be higher than your interest rate.

 

Fees that might be included in APR:

 

  • Application fees
  • Origination fees
  • Guarantee fees
  • Documentation fees
  • Annual fees
  • Other finance charges

 

Fees that typically aren’t included in APR:

 

  • Late payment fees
  • Insufficient fund fees

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Flexible business funding from QuickBooks Capital

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Desktop version or call 800.556.9145

Fixed rate vs variable rate

 

Since the interest rate is a big component of the cost of your loan, be sure to read the fine print to determine whether the rate is fixed or variable.

 

A fixed rate will stay the same over the life of the loan, which means you’ll have fixed, predictable payments. Meanwhile, a variable rate will fluctuate over time according to the base rate, as will your payments.

 

Some small business loans carry a fixed rate, which can help you budget for the payments. Credit cards tend to carry variable interest rates, which means the cost of your debt can fluctuate.

 

If you can choose between fixed and variable rates, the low end for the variable rate may be lower than the fixed rate, which might make it an attractive choice at first glance. Buyer beware—interest rates can climb quickly so make sure you’re comfortable with the highest end of the rate. Otherwise, you may get stuck with a much higher repayment than what you anticipated initially.

 

Why is APR so high on a short-term loan?

 

The APR is meant to help you compare apples to apples when it comes to rates and fees––the total cost of the loan––between lenders.

 

When you borrow, the lender must disclose all of the fees you’re charged, but not all lenders will charge these fees. For example, QuickBooks Capital charges none of these upfront fees and no prepayment fees.

 

If you’re using a short-term loan with a repayment term of less than a year, because the APR is the annual rate charged for borrowing money, its APR will be higher than a loan with a longer term. So be sure to compare the APRs of at least two offers with the same term.

 

Keep in mind that a shorter repayment term means you’ll pay less in interest charges than you would with a longer repayment term. That’s because the loan balance is outstanding for a longer period of time on a 3-year loan versus a 1-year loan.

 

If you take out a short-term loan, for example, you may have a higher interest rate or APR, but your overall cost is much lower than a long-term loan with the same rate because the life of the loan is much shorter.

 

Bottom line: the shorter your repayment term, generally the lower the borrowing costs.

 

Which factor should you pay attention to?

 

Both the interest rate and APR are important in helping you evaluate a loan or credit offer. First look at the interest rate across offers so you can see the initial interest charges you’ll pay, then look at the APR to see how additional fees and charges affect the total cost of borrowing.

 

It’s important to note that the APR does not have an impact on your regular loan payment, but the interest rate does.

 

Interest rates and fees affect the payment amount and overall cost of your loans, but so does the repayment period. QuickBooks Capital has a comparison calculator to show you how all of these factors come into play with different types of funding.

 

 

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