Monthly payment, total cost, and the true APR once fees are included — the figure that puts two offers on the same footing once fees are counted. Also shows what an extra payment saves, and flags the loan structures that cost borrowers most.
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The formula
APR is the number that compares two offers
The interest rate tells you what the lender charges on the balance. The APR tells you what the loan costs — rate plus fees, expressed annually. When two offers differ in both, APR is the figure that ranks them correctly for cost.
A $20,000 loan at 7.5% over five years with a $500 origination fee carries an APR of 8.57%. A competing offer at 8.2% with no fee has a lower APR and is genuinely cheaper — despite advertising a higher rate.
This is why regulators require APR disclosure, and why "rate" in an advert is a marketing figure rather than a price. Ask every lender for the APR in writing and compare those side by side rather than the headline rates. Confirm the loans are structured the same way first — an adjustable rate, a balloon or mortgage points can make even two APRs hard to compare directly, and the CFPB's own guidance is not to rely on APR alone in those cases.
The loan structures that cost borrowers most
| Structure | How it is sold | What it actually does |
|---|---|---|
| Balloon payment | "Lower monthly payments" | Payments are sized to a much longer schedule, so barely any principal clears. A large lump sum falls due at the end — often refinanced at whatever rate is available then |
| Rule of 78 | Rarely mentioned at all | Front-loads interest so paying off early saves far less than it should. Banned for many loan types in the US and UK, but still appears in some subprime and international lending |
| Prepayment penalty | "Standard terms" | Charges you for repaying early, removing the main way a borrower reduces total cost. Check for it before signing anything |
| Precomputed interest | "Simple, fixed total" | Total interest is fixed at signing rather than calculated on the declining balance. Early repayment does not reduce it proportionally |
| Very long terms | "Affordable payments" | An 84-month car loan halves the payment against 36 months and more than doubles the interest — while the car depreciates faster than the balance falls |
Three questions settle most of it before you sign. Is interest calculated on the declining balance? Is there a penalty for early repayment? Is there a balloon or final lump sum? A lender who cannot answer all three plainly, in writing, is telling you something.
Why extra payments do more than they appear to
An extra payment goes entirely against principal, and every dollar of principal removed also removes all the future interest that dollar would have carried. On a $20,000 loan at 7.5% over five years:
| Extra per month | Paid off in | Interest saved |
|---|---|---|
| Nothing | 60 months | — |
| $50 | 53 months | $549 |
| $100 | 47 months | $965 |
| $200 | 38 months | $1,552 |
One condition, and it is not optional: confirm your lender applies extra payments to principal rather than holding them against the next instalment. Some require you to specify this in writing on each payment. If it goes toward next month instead, none of the saving above happens — you have simply paid early.
Choosing a term
| Shorter term | Longer term |
|---|---|
| Higher payment | Lower payment |
| Substantially less total interest | Substantially more total interest |
| Often a slightly lower rate | Often a slightly higher rate |
| Less flexibility if income drops | More breathing room month to month |
| Equity builds faster on an asset | Risk of owing more than the asset is worth |
The middle path many advisers suggest: take the longer term for the lower required payment, then pay it at the shorter term's amount voluntarily. You capture most of the interest saving while keeping the right to fall back in a difficult month. The only cost is the slightly higher rate, which the flexibility usually justifies.
What the fee does to the rate you were quoted
An origination fee is deducted before the money reaches you, so you borrow one amount and repay against another. The advertised rate does not move; the effective cost does:
| Origination fee | You receive | Monthly payment | True APR |
|---|---|---|---|
| None | $20,000 | $405.53 | 8.00% |
| 1% — $200 | $19,800 | $405.53 | 8.43% |
| 2.5% — $500 | $19,500 | $405.53 | 9.08% |
| 5% — $1,000 | $19,000 | $405.53 | 10.20% |
The payment is identical in all four rows. Nothing on the statement changes, and the real cost of the money rises by more than two percentage points. This is why US lenders must disclose APR under the Truth in Lending Act, and why the APR box — not the headline rate — is the field to compare first between two offers.
Simple interest, amortised, and precomputed
Three loans can carry the same rate and behave completely differently when you try to pay one off early:
| Structure | How interest accrues | Paying off early |
|---|---|---|
| Amortised most personal loans | On the outstanding balance, recalculated each period | Saves the remaining interest. Every extra dollar cuts the balance every future payment is charged against |
| Simple interest many car loans | Daily on the balance | Saves interest, and paying a few days early saves a little more |
| Precomputed some subprime lending | Total interest fixed at signing and added to the balance | Saves little or nothing. Rebates may follow the Rule of 78, which front-loads interest so an early payoff refunds far less than it should |
The Rule of 78 is worth recognising by name. It weights interest towards the early months, so a borrower halfway through a five-year loan has paid far more than half the interest and owes far more than half the principal. It is restricted or banned for longer terms in many jurisdictions and still appears in short-term consumer credit. If a contract mentions it, the loan is more expensive to escape than the rate suggests.
Common mistakes
Frequently asked questions
What is the difference between interest rate and APR?
The interest rate is what the lender charges on the outstanding balance. The APR includes that plus origination and administration fees, expressed as a single annual figure. A 7.5% loan with a $500 fee has an APR of about 8.57% — so an 8.2% loan with no fees is genuinely cheaper despite the higher headline. Lead with APR, not the advertised rate, when you compare offers.
Should I take a longer term for a lower payment?
Only if you need the lower payment, and knowing what it costs. Doubling a term more than doubles the interest, because you owe more for longer. A common middle path is to take the longer term for the flexibility of a lower required payment, then pay it at the shorter term's amount voluntarily — capturing most of the saving while keeping the option to fall back.
Do extra payments really save that much?
Yes, provided they go to principal. Every dollar of principal removed also cancels all the future interest that dollar would have generated, so the effect compounds backwards. On a $20,000 loan at 7.5%, an extra $100 a month saves $965 and clears it more than a year early. Confirm with your lender that extra payments reduce principal rather than being held against the next instalment — some require it in writing.
What is a balloon payment?
A large lump sum due at the end of the term. Payments are calculated as though the loan ran much longer, which keeps them low while barely reducing the balance — then the remainder falls due at once. It makes a loan look affordable that is not, and the usual plan is to refinance, which depends on your future credit and on rates nobody can predict. Know the exact amount and date before agreeing.
Why is so much of my early payment interest?
Because interest is charged on the outstanding balance, which is largest at the start. The payment is constant, so as the balance falls, the interest portion shrinks and the principal portion grows. This is why extra payments early are worth far more than the same amount late — there is more remaining interest to cancel.
What is the Rule of 78?
An old method that front-loads interest so that paying off early saves much less than it should. It is banned for many loan types in the US and restricted in the UK, but still appears in some subprime and international lending. Ask whether interest is calculated on the declining balance. If a lender cannot answer that plainly, that is itself the answer.
Can I trust this figure for a loan application?
For planning and comparison, yes. For the application itself, work from the lender's written offer. Their figure will differ slightly through rounding conventions, and their rate depends on your credit profile rather than the one you assumed. Use this to know roughly where you stand and which questions to ask.
Is my information stored?
No. Everything runs in your browser with no server request and nothing saved. Loan amounts and income details are exactly the kind of information that should not be handed to a website.
Sources
- US Consumer Financial Protection Bureau. Regulation Z, 12 CFR Part 1026 — the Truth in Lending Act implementing rule. Defines APR, what must be included in the finance charge, and the disclosure a lender must give before you sign.
- Federal Reserve Board. “Consumer Handbook on Adjustable-Rate Mortgages” and the Regulation Z Official Staff Commentary. The source for how APR is computed from the amount actually advanced rather than the face value of the loan.
- UK Financial Conduct Authority. CONC 3 and the Consumer Credit sourcebook. The equivalent UK requirement, using representative APR — which at least 51% of accepted applicants must receive.
- European Union. Consumer Credit Directive 2008/48/EC, Annex I. Sets the standard APR formula used across member states.
- US National Consumer Law Center. The Cost of Credit. The standard reference on precomputed interest, the Rule of 78 and where each remains lawful.
- Formula. The payment is the standard annuity equation,
P × r ÷ (1 − (1 + r)−n), where r is the periodic rate and n the number of periods. APR is solved numerically by bisection, because the equation has no closed-form solution for the rate.
Every figure in the tables above is computed from these formulas rather than quoted. APR values are solved to within 0.001 percentage points, which is finer than any lender discloses.
Related calculators
See the full list of Financial calculators, or try:
- APR Calculator — the true cost once fees are counted
- Auto Loan Calculator — vehicle financing specifically
- Mortgage Calculator — home loans with tax, insurance and PMI
- Amortization Schedule Calculator — the full year-by-year table
- Debt-to-Income Calculator — what lenders will approve
- Debt Payoff Calculator — multiple debts in the best order