Annual Percentage Rate vs Interest Rate - Difference and Comparison

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	Annual Percentage Rate	Interest Rate
Definition:	Annual Percentage Rate (APR) is an expression of the effective interest rate that the borrower will pay on a loan, taking into account one-time fees and standardizing the way the rate is expressed.	Interest is a fee on borrowed capital. Interest rate is a "rent on money" to compensate the lender for foregoing other useful investments that could have been made with the loaned money.
Transaction costs:	Transaction costs and fees are taken into account when calculating APR.	Typically, interest rates do not include transaction costs.

When consumers borrow from a financial institution (for a loan or a mortgage), they pay interest. The term APR is used in such cases when the financial institution lends and the consumer borrows.

While interest rate is the pure cost of borrowing money, APR includes other costs and fees that the lender charges the borrower.

[edit] Example of Difference

Suppose the principal amount of a loan is $100, the interest rate is 5% and transaction costs and fees are $3. In this scenario, the borrower will effectively get a loan of only $97. At the end of 1 year the interest paid will be $5 (5% of $100). This interest payment of $5 is 5.154% of $97. Therefore, the effective rate that the borrower pays (a.k.a. Annual Percentage Rate) is 5.154%.

[edit] Why APR is used

Due to transactions costs and fees, the APR is always higher than the nominal interest rate. Therefore, APR represents the "true cost" to the borrower, and is a better measure of the cost of borrowing.

Another advantage of APR is that it allows the borrower to better compare the cost of borrowing from different lenders, since they may all have different fee structures. It is quite possible that a lender may charge a higher interest rate but a lower fees. This may be a better deal than a lender charging lower interest but high upfront transaction costs. Since APR factors these costs in, the comparisons between lenders are fair and accurate.