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APR vs Interest Rate for Student Loans

APR vs Interest Rate for Student Loans
Nancy Bilyeau

Nancy Bilyeau

Updated March 14, 2022
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Editor’s note: Lantern by SoFi seeks to provide content that is objective, independent and accurate. Writers are separate from our business operation and do not receive direct compensation from advertisers or partners. Read more about our Editorial Guidelines and How We Make Money.
Understanding the role that interest plays when you take out a student loan is crucial. On the surface of it, interest rates and APR seem simple and straightforward. They both represent your cost of borrowing money for a loan. But if you don’t grasp the significance of interest, and learn the difference regarding APR vs. interest rates, you could be in for some unhappy surprises down the road.

What Does Interest Rate Mean?

Look at interest as the cost of borrowing money. The higher the interest rate, the more money will be added to the original amount that was borrowed.A very simple example to what does an interest rate mean: if you borrow $100 with a 5% interest rate, you will pay $105 dollars back to the lender. Interest is spread out over the life of a loan, so the number of years that it takes you to pay the loan off totally will affect how much interest you pay. That amount of interest can be estimated, but if it turns out that it takes you longer to pay off the loan than you expected, you’ll end up paying more interest.

Pros of Interest Rate Student Loans

When you receive a federal student loan–which is what the majority of students use to pay for their college education–the interest rates for loans are fixed by the government. Here are the interest rates for the 2021-2022 school year:
  • The interest rate for Direct Subsidized Loans and Direct Unsubsidized Loans for undergraduates is 3.73%
  • The interest rate for Direct Unsubsidized Loans for graduate students is 5.28%
If you are interested in a private student loan, the interest rate is set by the lender–a bank or other financial institution, the college itself or another source–and takes into account your credit rating, income history, and debt to income ratio. Since most students don’t yet have long impressive histories in these areas, they often turn to a cosigner with a strong record.

Cons of Interest Rate Student Loans

If you do not possess a strong credit rating and cannot find an impressive cosigner, you might receive a private loan offer with a high interest rate. If you take the loan, such an interest rate could cost you a lot of money over the years.Another caution: An interest rate, which is reflected as a percentage of your principal, does not include other fees and charges.If you just compare straight interest rates, you might miss the big picture when it comes to the total cost of the loan. Those additional fees can sometimes make an impact.

What Is Annual Percentage Rate (APR)?

In addition to paying interest on your loan, you may be charged origination fees and other expenses with your loan. The Annual Percentage Rate (APR) is a calculation that lenders are required to make under the Truth in Lending Act to help people understand these additional fees and expenses.  The APR is popular for car loans and other borrowing.You may be wondering, “What are these fees on the APR?” The answer is: application fees and origination fees.Application fees are flat fees charged once for completing a loan application. Origination fees are charges connected to processing your loan. 

Pros of Annual Percentage Rate (APR) Student Loans

The APR gives you information you need. In general, the more fees and expenses are added to a loan, the higher the APR. If a loan has no additional fees, the interest rate and APR will be the same.When you’re shopping for student loans, comparing interest rate student loans to APR student loans is like apples to oranges. But comparing the APR loans is more like apples to apples.If you just compare straight interest rates, you could miss the big picture in terms of the total cost of the loan, and sometimes those additional fees can make a big impact.

Cons of Annual Percentage Rate (APR) Student Loans

The APR student loan is usually higher than the interest rate student loan, since it includes fees, so you will pay more.Another factor regarding the APR is the time the loan might be in deferment or student loan forbearance, which is when payments are on hold but interest is still accruing.When payments resume, that accrued interest is capitalized (which means added to the loan’s principal). The amount spent on interest increases, and so does your APR.Since it’s unknown if you might put your loan in forbearance, a new loan’s APR won’t typically reflect this cost, but it will definitely affect your APR on the back end.

Choosing the Right Student Loan

When considering a new student loan or student loan refinancing options, you must ask questions about APR and interest rate. That way you will be informed of any fees or charges and how they are to be paid. And be sure to ask about what happens if the loan goes into forbearance.The repayment of federal student loans is set to resume on August 31st, 2022 after a pause of more than two years.Finding the best interest rate is only one part of the loan consideration process. You’ll also want to look at how long the loan stretches out for. If you are paying down your federal student loans, you apply for government loan forgiveness programs and income-driven plans. If you refinance to a private student loan, you may be able to get a lower interest rate but you will not be eligible for any of these programs.

Current Student Loan Rates

For the 2021-2022 school year, for undergraduates, the subsidized federal loans have an interest rate of 3.73 percent, while graduate students have interest rates of 5.28 percent or 6.28 percent for unsubsidized loans. Private student loan interest rates range from 1 percent to 13 percent and are generally based on your credit score. Through Lantern, you can research student loan refinance options. Interest rates are expected to rise later this year. If you refinance soon, you can lock in a lower rate by choosing a fixed-rate loan. But also, if you choose a private loan or if you refinance a federal loan, you lose the possible forgiveness option for federal loans.
Photo credit: iStock/cagkansayinThe tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.SOLC112172

About the Author

Nancy Bilyeau

Nancy Bilyeau

Nancy Bilyeau writes about student loans, mortgages, car insurance, medical debt and many other finance topics for Lantern. A veteran of the magazine business, she has edited stories on personal finance for Good Housekeeping and DuJour magazines and has written articles for The Wall Street Journal, Readers' Digest, Parade, Town & Country and Lifetime/A&E, among others. She is a graduate of the University of Michigan.
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