APR vs. Interest Rate

APR vs. Interest Rate

APR vs. Interest Rate

When you evaluate the costs of a line of credit or easy loans, you must be able to understand the difference between the advertised or nominal interest rate and the APR (annual percentage rate), as it is referred to in Canada. The nominal interest rate is used to calculate the interest expense on one’s loan.

Difference between APR and interest rate

The nominal interest rate also referred to as the simple interest rate, is calculated based only on the principal balance originally borrowed. So, for example, in case you borrow $100 for a year at 10%, you will pay back $110 at the end. The APR, also referred to as compound interest and effective interest rate, is calculated by taking into consideration not only the principal amount originally borrowed but also the accumulated interest. So, for example, in case you borrow $100 for a year at 10%, you will pay back $112.4, making the APR 11.2%. The APR is what mortgage lenders in Canada are required to present to you.

It goes without saying that actual mortgages involve a lot more complex than the examples we have provided here, particularly because mortgage payments are made on a monthly basis, if not more frequently. However, this has no bearings on the results: the APR is always a bit higher than the nominal interest rate.

In other words, the interest rate represents the cost of borrowing money. Where it concerns mortgage loans, you can either get an adjustable rate mortgage or a fixed rate mortgage. Only the interest percentage will be included in the interest rate, the interest percentage that you shall be charged for having borrowed the money. It does not, however, contain other fees, fees you may also be required to pay on the loan, such as documentation fees, closing fees, origination fees etc.

The APR, on the other hand, offers a comprehensive evaluation of what amount you will pay for money that you have borrowed. It provides the full cost of the borrowed money, expressing it in the terms of interest rates, including the interest as well as additional fees, such as documentation fees, origination fees, and other financial charges.

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