If you’re thinking of buying land, then it’s a good idea to brush up on some terms commonly used in the finance world. You’ve probably heard the terms interest rate and annual percentage rate (APR) many times in your life, but you may not be aware of the difference between the two.
Anytime you’re considering a loan — in the form of a mortgage, a credit card balance, or an owner financed land deal — these definitions are essential to understanding the terms of that loan. First, we’ll go over what an interest rate is vs. an APR. Then, we’ll break down in detail what this means if you purchase land through Land Elevated. So read on to find out all about interest rate vs. APR on owner financed land.
Interest Rate vs. APR: What’s the Difference?
Both interest rates and APRs are expressed as percentages, which can make things confusing. However, there are usually some very distinct differences between an interest rate and an APR.
Interest Rate
An interest rate is the percentage a borrower will pay on the principal loan amount. This percentage is used to determine the cost of borrowing the principal amount of the loan. Since interest rates are calculated yearly, loans with shorter terms will require larger payments up-front but will be more favorable in terms of total interest paid than loans with longer terms.
Interest rates fluctuate for a number of reasons, but the most notable one is the Federal Reserve. In times of economic growth, interest rates tend to rise to encourage saving rather than spending. During recessions, interest rates tend to lower, encouraging people to spend and secure loans.
While a loan’s interest rate is certainly a number you should be aware of, it’s not a complete number for determining the pertinent details of a loan.
APR
An APR (Annual Percentage Rate) includes the interest rate the borrower will pay on the principal loan amount plus any fees included in the management of the loan. On a mortgage, these fees will often include things like mortgage insurance, closing costs, and brokerage fees. These fees don’t affect your interest rate, but they do need to be factored into your monthly payments.
On a personal loan, the APR often includes a one-time origination fee. Like interest rates, APRs are also expressed as percentages.
Unfortunately, it can be difficult to determine the monthly payments when breaking down an APR on a loan. Since these loans are paid off monthly — combining the interest rate, fees, and payments on the principal — it requires a somewhat complex formula.
As you pay off the loan, the principal lowers. And since you only pay the APR on the principal, the amount of the monthly payment that goes toward the principal and the interest changes each month. As you make payments on the loan, the portion of your monthly payment that goes toward the interest lowers — because you’re lowering the principal. Meanwhile, the portion of your standard monthly payment that goes toward the principal increases.
Then, at the end of the loan term, you’ve paid both the interest and the principal in full.
This can be hard to grasp at first. Luckily, there are plenty of online loan calculators you can use to determine the specifics of a given loan.
Now, you can see what the difference between an APR and an interest rate is. The interest rate of a loan is included in the APR, but it’s not the same thing. This is why an APR will always be equal to or higher than the interest rate.