If you’ve ever taken out or refinanced your student loans, you probably know the interest rate of your loan and may have seen the letters ‘APR’ on your statement, which stand for Annual Percentage Rate. Understanding the difference between the interest rate and the APR is important, because while they both measure the cost of borrowing money, they are not the same. Knowing the difference could save you thousands of dollars on your student loans.
What is the difference between the interest rate and the APR on a student loan?
The interest rate on a student loan is the cost to borrow money. It is shown as a percentage and does not reflect any fees or other charges you may pay for the loan. The APR goes a step further by taking the interest rate on a student loan and adding in any upfront costs, such as an origination fee. While the APR is also expressed as a percentage, it measures the total cost of borrowing money on an annualized (yearly) basis.
By law, private student loan issuers must show customers the APR to facilitate a clear understanding of the actual interest rates and fees applicable to their agreements. In the U.S., the calculation and disclosure of APR is governed by the Truth in Lending Act.
Tip: While U-fi and many private student loan lenders do not charge an origination fee, some lenders do. Be sure to carefully read the loan terms before applying for and accepting a loan.
Why is it important to know the APR if I know the interest rate?
As mentioned above, the APR gives a more complete picture of the cost of borrowing. For student loans and student loan refinancing, if the lender doesn’t charge an origination fee and you immediately begin making full principal and interest payments, the interest rate and the APR will likely be the same. However, if you are charged an origination fee or you defer making principal and/or interest payments while you are in school, your APR will not likely be the same as your interest rate. By looking at both the interest rate and the APR, you will be able to get a clearer picture of your expected monthly payment and the total cost of the loan.
Does the interest rate and APR tell the complete story?
While the interest rate and the APR are useful tools to help understand the cost of borrowing and to compare different loans, they don’t always tell the complete story. For instance, federal Direct Subsidized Loans, Direct Unsubsidized Loans, and Direct PLUS Loans come with an origination fee, but the fee is deducted from the loan disbursements, so the origination fee is not included in the APR. Thus, if you took out a $10,000 federal Direct PLUS Loan with its 4.272% origination fee, you would only receive $9,572.80, but you would have to pay back the entire $10,000, plus any accrued interest on the loan.
Also, the stated APR may or may not include any borrower benefits associated with the loan, such as an interest rate reduction for auto debit payments or cash back rewards for good grades. Some federal student loans also come with loan forgiveness programs, so be sure to take all these into account when comparing loan offers.
Tip: The interest rate and the APR for a variable rate student loan reflects the interest rate and costs at the time you take out the loan, so if interest rates change, the APR would change as well.
In the end, knowing the difference between the APR and interest rate will help you make the most informed decision when it comes to applying for and taking out student loans.