The interest rate is what the balance is charged. The annual percentage rate is what the whole arrangement costs once the fees are folded in, expressed as the rate that would produce the same payments if there were no fees at all. On a $25,000 loan at 7.5 per cent over 60 months, a $750 origination fee turns a 7.5 per cent rate into an 8.79 per cent APR.
Both numbers are true and they answer different questions. The rate tells you how the balance behaves; the APR tells you which of two offers is cheaper.
How is the APR actually calculated?
By working backwards. Take the payments the loan actually requires, then ask what rate would generate those same payments on the amount you actually received rather than the amount you nominally borrowed.
The example loan pays $500.95 a month for 60 months. If a $750 fee comes out of the advance, you received $24,250 and are paying $500.95 for five years against it. The rate that makes those two sides balance is 8.79 per cent, and that is the APR.
| Fee on a $25,000 loan | Monthly payment | Effective APR |
|---|---|---|
| None | $500.95 | 7.50% |
| $375 | $500.95 | 8.14% |
| $750 | $500.95 | 8.79% |
Notice the payment does not move. The fee changes what the loan cost, not what it charges — which is exactly why comparing monthly payments hides it.
Why is the gap wider on short loans?
Because a one-off fee is spread over fewer payments. The same $750 on a five-year loan adds 1.29 points to the APR; on a thirty-year mortgage it would add a small fraction of a point, because there are 360 payments to absorb it rather than 60.
This is the single most useful thing to know about APR. On short-term borrowing the fee dominates and the APR is the number that matters. On long-term borrowing the rate dominates and the APR barely moves — so an APR quoted on a mortgage is much closer to the rate than one quoted on a personal loan.
Which fees count?
It depends on the jurisdiction, and that is the honest limitation of APR as a comparison tool. Rules define a set of charges that must be included and a set that may be excluded, and two lenders can place the same charge on different sides of that line.
What is generally in: origination and arrangement fees, discount points, broker fees, and required insurance where the lender mandates it. What is generally out: charges that are optional, and third-party costs you would pay regardless of who lends to you.
The result is that APR is reliable for comparing like with like and unreliable across product types. Comparing two personal loans by APR works. Comparing a personal loan to a credit card by APR compares two calculations that were never intended to meet.
What does the APR not tell you?
Four things, each of which can outweigh the difference the APR describes.
- How long you will keep the loan. APR spreads the fee over the full term. Repay in year two and you paid the whole fee over two years, so the real cost is far higher than the quoted APR.
- Whether the rate is fixed. A variable-rate APR is calculated on today’s rate and tells you nothing about tomorrow’s.
- What happens if you overpay. The example loan costs $5,056.92 in interest over 60 months. Add $100 a month and it clears in 49 months with $4,043.31 of interest — $1,013.61 saved, on an APR that never mentioned the possibility.
- Penalties. Early repayment charges, late fees and payment-protection terms sit outside the calculation entirely.
How do you compare two offers properly?
Line up the term first, because APR is only comparable at equal terms. Then compare APR rather than rate, and check the total paid as a sanity check on both.
A worked comparison: a 7.5 per cent loan with a $750 fee has an 8.79 per cent APR. An 8.5 per cent loan with no fee has an 8.5 per cent APR and is cheaper, despite the higher headline rate — as long as both run the full 60 months. Repay either in year two and the fee-free loan wins by more.
Questions people ask
Is APR always higher than the rate? It is equal when there are no fees and higher when there are. It cannot be lower, because the fees can only add cost.
What about APY? A different measure entirely, used for savings. APY expresses what compounding adds to a deposit rate; APR is a borrowing cost and does not compound in the same way.
Does the payment change when the APR does? No. The payment follows the rate and the term. The APR is a description of the deal, not an input to the arithmetic.
Why do two lenders quote different APRs on the same rate? Because their fees differ, or because they have classified the same fee differently. Asking for the itemised fee list is the only way to tell which.
Does APR include the deposit? No. It describes the cost of the money you borrowed, so a larger deposit reduces the interest paid without changing the APR at all.
Compare deals on APR and behaviour on rate. The loan calculator shows the payment, total interest and what an overpayment does to both; the car loan calculator adds tax and trade-in to the same maths, and the mortgage calculator is where the fee spread over 360 payments stops mattering much.