Lesson 1 of 3 · 2 minute read
How interest and APR work
What borrowing really costs, and how to compare loan offers.
When you borrow money, you pay back more than you borrowed. The extra is the cost of borrowing.
Interest
InterestThe price of borrowing money. You pay interest when you borrow, and you can earn interest when you save.More in the glossary is the price of borrowing money. The amount you borrowed is called the PrincipalThe amount you borrowed, not counting interest.More in the glossary. Each payment usually covers some interest and some principal.
APR
The APRAnnual percentage rate. The yearly cost of borrowing money, including interest and some fees, shown as a percent.More in the glossary, or annual percentage rate, shows the yearly cost of a loan as a percent. It includes interest and some fees. Lenders have to tell you the APR before you agree to a loan.
For a rough idea of the interest on a credit card each month, divide the APR by 12:
- 24% APR ÷ 12 = about 2% a month.
- On a $1,000 balance, that’s about $20 in interest for the month.
Compare more than the monthly payment
A lender can make the monthly payment look small by making the loan longer. But a longer Loan termHow long you have to pay back a loan, like 4 years (48 months).More in the glossary means you pay interest for longer.
| Length | Monthly payment | Total interest |
|---|---|---|
| 3 years | $205.07 | $1,382.35 |
| 4 years | $163.96 | $1,869.97 |
| 5 years | $139.61 | $2,376.56 |
The 5-year loan has the smallest payment, but it costs about $1,000 more in interest than the 3-year loan.
Watch for add-ons
Ask what’s included in a loan before you sign. Extras like extended warranties or credit insurance can be added to the loan, which makes it cost more. You can usually say no to them.
InterestThe price of borrowing money. You pay interest when you borrow, and you can earn interest when you save.More in the glossary is the price you pay to borrow money. You pay back more than you borrowed.
The APRAnnual percentage rate. The yearly cost of borrowing money, including interest and some fees, shown as a percent.More in the glossary shows the yearly cost of a loan as a percent. It includes interest and some fees. Lenders have to tell you the APR before you agree.
Don't look only at the monthly payment. Compare the APR and the total cost of each loan.
A Loan termHow long you have to pay back a loan, like 4 years (48 months).More in the glossary has smaller payments. But you pay interest for longer, so it usually costs more in total.
Ask what is added to a loan before you sign. Extras like warranties make it cost more. You can usually say no to them.