Interest Rate
An interest rate is the cost of borrowing the principal amount, expressed as a percentage. Unlike APR, the interest rate doesn't include fees. It's the number used to calculate how much interest accrues on the outstanding balance, but it's a less useful comparison number than APR because two loans at the same interest rate can have very different total costs.
The interest rate is the percentage the lender charges for the use of the principal, expressed as an annual rate. On a fixed-rate loan, this number doesn’t change for the life of the loan; on a variable-rate loan, it can adjust based on a benchmark like the prime rate.
Why interest rate alone isn’t enough
Two lenders can offer the same interest rate with very different costs. Lender A offers 25% with no fees; Lender B offers 25% with a $50 origination fee. Same interest rate, different actual cost. APR captures both, which is why federal law requires APR disclosure rather than just interest rate.
If you’re comparing offers and only one number is shown, make sure you know whether it’s the interest rate or the APR. The interest rate is almost always lower, which makes lenders prefer to advertise it. The APR is what tells you the truth about cost.
How interest is calculated on installment loans
On a fixed-rate amortizing loan, interest is calculated each period (usually monthly) on the outstanding balance. As you pay down principal, less of each payment goes to interest and more goes to principal. This is why early payments on a 12-month loan are mostly interest, while late payments are mostly principal.