Reading a loan offer: APR, origination fees and the total

A loan offer will usually show you three numbers: an interest rate, a monthly payment, and a term. The one that tells you what the loan actually costs is often in smaller type underneath, and it is called the APR.

The interest rate and the APR are not the same thing. The rate is what you are charged for borrowing the money. The APR folds in the fees as well — above all the origination fee, which many personal lenders deduct before the money reaches you — and expresses the whole cost as a yearly percentage. Two loans can carry the same 11 percent rate and very different APRs, and it is the APR that reflects what leaves your account.

Take $10,000 over three years at 11 percent. With no fees the APR is also 11 percent, and you repay about $11,790 in total. Now add a 5 percent origination fee. The lender sends you $9,500 but charges interest on the full $10,000, so you still repay about $11,790 — except you only ever had $9,500 of it. The real cost is $2,290 on $9,500, and the APR works out at roughly 14.5 percent. Same rate on the page. A more expensive loan.

That is why the APR is the number for comparing offers, and why lenders are required to print it. It is also why the monthly payment is the wrong number. A lower payment usually means a longer term, and a longer term means more interest even at a lower rate. The same $10,000 at 9 percent over five years costs about $2,460 in interest; at 11 percent over three years it costs about $1,790. The cheaper-looking loan is the dearer one.

Two more things to look for before you sign. Whether there is a prepayment penalty — a charge for clearing the loan early — which matters if you think you might refinance or come into money. And whether the rate is fixed. Nearly all personal loans are, but “rates as low as” in the advertising means the rate you are actually offered depends on your credit, and the number in the advert is the one almost nobody gets.