What is APR on a personal loan, and how to compare offers by total cost

APR stands for annual percentage rate. It is the cost of a loan expressed as a yearly percentage of the amount borrowed, with certain fees folded in, and it exists so that two loans with different structures can be compared on one number. Under the federal Truth in Lending Act, every lender must disclose the APR, the finance charge, the amount financed and the total of payments before you sign. That makes APR the single most useful number on any loan document, provided you know what it includes and what it leaves out.

This article explains what APR is, works through a $2,000 example, and sets out how to compare offers by what they will actually cost. LoanAdvice is not a lender; the examples here are illustrations, and the rate on any real offer comes from the lender that makes it.

APR versus interest rate

The interest rate is what the lender charges for the use of the principal. The APR starts with the interest rate and adds certain costs of getting the loan, most often an origination fee, then expresses the whole thing as a yearly rate over the loan’s term. If a loan has no fees, the APR and the interest rate are the same. If it has fees, the APR is higher, and the gap tells you how much the fees matter.

Not every charge is in the APR. Late fees, returned-payment fees and optional add-ons such as credit insurance are usually outside it, because they depend on what happens after you sign. That is why the APR is the place to start rather than the place to stop.

A worked example: $2,000 over 24 months

Take a $2,000 personal loan repaid over 24 months at 24.99% APR with no fees. The monthly payment works out to about $106.72. Over 24 payments that is about $2,561 in total, so the loan costs about $561. This is the representative example on our disclosures page; it is an illustration, not an offer.

Now change one variable at a time.

Change the rate. The same $2,000 over 24 months at 35.99% APR is about $118 a month and about $2,834 in total: about $273 more for the same money over the same time. That is what eleven points of APR are worth on a loan this size.

Change the term. Keep 24.99% APR but stretch the loan to 36 months. The payment falls to about $79.51, which looks like relief, but the total climbs to about $2,862, roughly $300 more than the 24-month version. Shorten it to 12 months instead and the payment jumps to about $190 while the total falls to about $2,281. A lower payment is not a cheaper loan; it is a longer one.

Add an origination fee. Suppose the 24-month loan at 24.99% carries a 5% origination fee, deducted from the proceeds. You still owe $2,000 and still pay about $106.72 a month, but only $1,900 reaches your account. Because you received less for the same payments, the APR is about 30.5%, not 24.99%. The lender is required to state that higher figure, which is exactly how the fee is meant to show up. If you need the full $2,000 in hand, you would have to borrow more, and the payments rise with it.

Where short-term loans fit on the same scale

Payday and other short-term loans are usually priced as a flat fee rather than a rate, which makes them look cheap next to a double-digit APR. The law requires the fee to be disclosed as an APR too, and the conversion is unforgiving. A fee of $15 per $100 borrowed for two weeks is 15% of the principal in 14 days; annualized, that is about 391% APR. APRs on short-term loans vary by state and can exceed 400%. On a $500 loan, a $75 fee for two weeks is the same 391%, and a single rollover doubles the cost without touching the principal.

The point is not that a high APR is always the wrong choice; it is that the number lets you see what you are paying. A $75 fee to bridge two weeks may be a decision you make with open eyes. A $75 fee every two weeks for six months is a $975 cost on a $500 loan, and the APR is what would have told you that on day one. Our comparison of personal loans and payday loans goes further into the difference.

How to compare offers by total cost

Two offers can only be compared cleanly when they are for the same amount over the same term. When they are, the lower APR is the cheaper loan, full stop. When they are not, use total cost.

1. Line up the amount financed. Fees deducted from the proceeds mean you receive less than the face amount. Compare what actually lands in your account.
2. Add up the total of payments. The Truth in Lending disclosure states it. If you only have the monthly payment and the term, multiply them.
3. Subtract what you received. Total of payments minus the amount that reached you is the cost of the loan in dollars. That figure, not the APR and not the payment, is what you are deciding to spend.
4. Check what sits outside the APR. Late fees, returned-payment fees, prepayment penalties and any optional products the lender has pre-selected. A loan with no prepayment penalty is worth more than its APR suggests if you expect to pay it off early.
5. Confirm the rate is fixed. Most personal loans have fixed rates. A variable rate makes every number above a starting point rather than a promise.

A short example of why the total matters: a $2,000 loan at 24.99% over 36 months ($2,862 in total) costs more than a $2,000 loan at 35.99% over 12 months (about $2,411 in total), even though its APR is eleven points lower. The 36-month loan may still be the right choice if only its payment fits your budget, but you should know you are paying about $450 for that room.

Questions to ask before you sign

• What is the APR, and does it include an origination fee?
• What is the total of payments, and what will actually be deposited?
• Is the rate fixed for the full term?
• Is there a prepayment penalty?
• What are the late and returned-payment fees, and when do they apply?
• Does the lender report payments to the credit bureaus?

Every one of these has a plain answer in the loan agreement. A lender that will not give it before you sign is telling you something.

Where the rate on an offer comes from

If you use our request form, LoanAdvice shares your request with its lending partners and their service providers, and each lending partner decides whether to present an offer and at what rate. The APR depends on the lender, your credit profile, the amount, the term and your state. Each lender discloses its own APR, fees and repayment schedule before you sign, as the law requires, and a hard credit inquiry may be part of accepting an offer; our guide to soft pulls and hard pulls explains when. Read the lender’s documents, run the total-cost arithmetic above, and compare the offer against any other you can get before you accept.