What’s the difference between interest rates and APRs?

The concept of an interest rate is simple. You pay a percentage of what you borrowed for the privilege of using someone else’s money. It’s like a money rental. As long as you hold some portion of the money you borrowed, you’re charged rent on it.

But that doesn’t mean what you pay to borrow is simple. There are also fees, which are not included in your interest rate. APR (annual percentage rate) helps solve for this. It includes both interest and fees and represents the combined annual cost of borrowing as a percentage. APRs add transparency to the borrowing process, but they can be confusing. What does each number tell you? Does one number matter more?

APR — a cost of borrowing

Many of the fees lenders charge make sense. Fees for working to close on the loan, lower your interest rate or administer the loan are costs for specific services. But sometimes lenders tack on additional costs that are harder to justify. If you focus only on your interest rate, you might not realize how much you ultimately pay. This is why lenders are required to disclose an APR.

An APR adds up the fees you pay across the full term of your loan, combines them with the total interest, divides the cost up on a per-year basis then calculates this cost as a percentage of the loan amount, or principal.

Consider this example. A two-year loan for $10,000 with $100 in fees means you’ll pay an average of $50 per year in fees. This comes out to 0.5% of the overall loan amount ($50/$10,000). Add the 0.5% to your interest rate and you get your APR. So, if you’re paying 8% interest on your loan, your APR is 8.5%.

What’s a reasonable APR?

The size of the difference between your interest rate and APR can vary. In general, the longer the term of the loan, the smaller the difference . This is because the fees are spread over more years. For example, if you have a five-year loan with $1,000 in fees, that comes out to $200 per year in fees. The percentage is based on that $200. A 10-year loan for the same amount with the same APR would be charging $200 per year in fees for twice as long, making the overall cost in fees $2,000. That’s why, when comparing two APRs, time matters a lot. If the percentages are equal but the term isn’t, you may be paying a lot more in fees with the longer-term loan.

If you’re not sure whether your APR is a good deal, do the math on your fees. Does the total over the full term of your loan add up to a number that feels reasonable to you? This can sometimes help you better put the percentages in perspective.

What fees are included in an APR?

It’s common to pay fees to get a loan. But not all fees are represented in an APR, so it’s important to sort through the charges to find out whether your APR gives you the full picture of your costs.

Common fees calculated in an APR include:

• Origination — for processing a new loan
• Underwriting — for reviewing and verifying documents such as bank statements, credit reports, tax returns, balance sheets and more
• Administration — for servicing the loan from disbursal to the final payment
• SBA loan guarantee — a pass-through fee to cover what the SBA (Small Business Administration) charges lenders in order to guarantee a loan (only applies to SBA loans)

Fees that are not calculated in an APR include:

•  Fees triggered only in special circumstances, such as a late payment
• Attorney fees, if there’s a legal question to consider before granting a loan
• Credit checks
• Appraisal fees

There may be other fees that are less common that can be left off an APR, which means your APR doesn’t provide a complete picture of the cost of your loan. Don’t be afraid to ask whether fees you’re charged are represented in the APR.

Look out for your interests

Interest and fees are the cost of doing business. Understanding those costs and making sure they’re fair and transparent are what matters. To learn more about the costs when you borrow with Chase, speak with a Chase banker in your area.