How to compare loan offers: APR, fees and total cost

How do you compare two loan offers?

First, make the offers match: the same cash in your hands and the same number of months. Then compare two numbers: the APR, which rolls the lender’s interest and fees into one yearly rate, and the finance charge, which totals the same interest and fees in dollars. An offer that is lower on both costs less if you keep the loan to the end.

Two things complicate it. APR alone can’t rank offers with different terms, because a lower APR over more months can still mean more interest overall. And if you might repay early, an upfront fee costs more per year the sooner you do. Looking only at the interest rate or the monthly payment can point to the wrong offer, as the example below shows.

What do the interest rate, APR and finance charge each measure?

The APR is higher than the interest rate whenever the loan has fees that count as finance charges, and equal to it when there are none. So two loans at the same rate can have different APRs, and the loan with the lower rate can have the higher APR. The CFPB’s advice is to compare an APR only with another APR, never with an interest rate.

The APR is 12 times the monthly rate $i$ at which the payments, discounted back to the start of the loan, add up to the amount financed. This is the actuarial method in Regulation Z, Appendix J, shown here for a loan whose first payment is due one month after it starts:

Here $A$ is the amount financed, $M_k$ is the $k$-th monthly payment (all equal except, usually, the last one by a few cents), and $n$ is the number of payments. The lender sets the payment on the full loan amount at the note rate. The APR asks what rate those same payments represent on the smaller amount you actually received.

Worked example: two offers for $15,000 over 48 months

The rates and the fee below are example inputs, not current market rates. You need $15,000 and want to repay it over 48 months.

• Offer A: 8.99% interest, no fees.
• Offer B: 7.49% interest, with a 4% origination fee withheld from the loan proceeds.

Payments are rounded to the cent and interest is charged on the balance each month, so each loan’s final payment differs from its regular payment by a few cents (Offer A’s is $373.48). The totals include it.

1. As quoted, B’s payment is $10.59 lower, but you receive $600 less. The payment comes from the lower rate on the same loan amount. The fee doesn’t appear in it at all.
2. Receiving the same cash from B reverses the payment comparison. To end up with $15,000 after a 4% fee, you borrow $15,000 ÷ (1 − 0.04) = $15,625. The fee becomes $625 and the payment $377.72, which is $4.52 more than A’s. Over 48 months you repay $216.82 more than with A.
3. The APR flags this in both versions. For B as quoted, solve the equation above with $14,400 received and 48 payments of $362.61 (the last is $362.83). The result is $i$ = 0.8018% a month, and 12 × 0.8018% = 9.62%. The APR is the same when you borrow $15,625 because the fee is the same percentage of the loan. A flat-dollar fee behaves differently: the same fee raises the APR more on a smaller loan.

Should you pay a loan fee upfront or add it to the loan?

Paying the fee from your savings costs less in dollars than borrowing it, but it uses cash you may want for emergencies or that could be earning interest. When a lender withholds a fee, there are two ways to end up with the $15,000 you need from Offer B:

• Cover the gap from savings. Take the $15,000 loan, receive $14,400 and add $600 of your own. Your cost is $2,405.50 of interest plus the $600 fee: $3,005.50.
• Borrow the fee. Take $15,625 and receive $15,000. Your cost is $3,130.70, which is $125.20 more: a fee $25 larger (4% of a bigger loan) plus $100.20 of interest on the borrowed fee.

Both show the same 9.62% APR. Regulation Z subtracts a prepaid fee from the amount financed whether it is withheld or paid separately in cash, and the fee is 4% of the loan either way. So the APR won’t show which way is cheaper in dollars. Either way, B costs more than A ($3,005.50 against $2,913.88 even when you pay the fee yourself). Car loans raise the same question for dealer fees, which can be financed or paid at signing.

Does a longer loan cost more even when the payment is lower?

Yes, at the same rate. You owe the balance for more months, so you pay interest for more months. The CFPB’s mortgage guidance describes the same trade-off: a shorter term has higher monthly payments but typically a lower rate and a lower total cost.

Stretching Offer A to 60 months lowers the payment by $61.90 and adds $764.32 of interest. Offer C has both the lowest payment and a lower APR than A, yet it costs $1,281.43 more in interest because you borrow for two more years. That is why APRs only compare fairly at the same term: the APR is a cost per year, and a longer loan charges it for more years. Ask each lender for a quote at the term you actually want.

A longer term does buy flexibility. Suppose C charges simple interest, applies extra payments to principal and has no prepayment penalty. Paying A’s $373.20 every month would clear C in 48 months, with a final payment of $171.38. The interest would be $2,711.78, which is $202.10 less than A. This only works if you make the larger payment every month.

What if you pay the loan off early?

An upfront fee then pushes your yearly cost above the APR, and the sooner you repay, the higher it goes, because the fee is spread over fewer months. The APR assumes you make every scheduled payment, but a sale, a refinance or a windfall can end the loan early. The table adds Offer D: 6.49% with the same 4% fee, borrowing $15,625 to receive $15,000 (payment $370.47, APR 8.61%). On APR alone, D beats A.

Each cell is the cost of borrowing $15,000 if you repay the whole balance right after that payment, with the yearly rate in parentheses worked out like an APR over the shorter period. B and D are the versions that borrow $15,625 to receive $15,000. The table assumes simple interest and no prepayment penalty.

Each cost is the payments made plus the payoff balance, minus the $15,000 you received. For Offer A after 12 months, that is 12 × $373.20 = $4,478.40, plus a balance of $11,737.87, minus $15,000, which gives $1,216.27.

• A’s yearly cost stays at 8.99% whenever you repay. It has no fee, so you pay interest only for the months you borrow.
• B costs more than A whenever you repay, and the gap grows the sooner you do. It costs $461.20 more after 12 months and $216.82 more at full term.
• D is cheaper than A only if you keep it at least 30 months. Repaid after 29 months, it costs $6.69 more than A. Repaid after 12 months, it costs $318.87 more.

If you might repay within a year or two, a no-fee loan at a somewhat higher rate can cost less than an offer with a lower APR. For mortgages, the Loan Estimate’s “In 5 Years” figure gives a shorter-horizon view (see the questions below).

Is the loan with the lowest APR always the better deal?

No. Besides a different term (Offer C) or repaying early (Offer D), check these:

• Costs the APR leaves out. Regulation Z excludes some charges from the finance charge: application fees charged to every applicant, late and default fees, and on loans secured by real estate, fees such as title insurance, appraisal and credit reports. On a mortgage, compare the itemized origination charges and required services on each Loan Estimate too.
• Adjustable rates. The APR on an adjustable-rate loan doesn’t reflect the highest rate the loan could reach, so comparing it with a fixed-rate APR can mislead.
• Small APR gaps. For a loan with one advance and regular payments, a disclosed APR counts as accurate within 1/8 of a percentage point of the exact figure. When two APRs are that close, compare the finance charges in dollars.
• Prepayment terms. A Truth in Lending disclosure must state whether a penalty can be charged for paying early; a penalty would add to the early-payoff costs above. Precomputed interest, an uncommon method on auto loans, fixes the interest at the start, so paying early saves less than with simple interest (part of the unearned interest may be refunded).

A checklist before you choose

1. Same cash received and same term for every quote. If a fee is withheld, borrow enough to receive the cash you need ($15,625 for Offer B).
2. APR against APR, then the finance charge in dollars.
3. Each offer’s cost at the month you might realistically repay.
4. The prepayment statement, simple or precomputed interest, and fixed or variable rate.

Try it

These calculators round payments to the cent and charge interest monthly on the balance, as in this example, so these inputs reproduce the figures above. For your own loan, the APR on the Truth in Lending disclosure or Loan Estimate is the figure the lender is required to give you. A calculator’s result can differ slightly because of which fees count as finance charges, when the first payment falls and the 1/8-point tolerance.

• APR calculator: term 48 months, days to first payment at the default.
  • Offer B as quoted: loan amount $15,000, interest rate 7.49%, one fee of $600 paid at closing (deducted from what you receive). The APR is 9.62% on an amount financed of $14,400.00.
  • Offer B with the fee borrowed: enter the $15,000 you want to receive as the loan amount and change the fee to $625 added to the loan. The payment rises to $377.72 (on a $15,625 loan), the amount financed stays $15,000.00, the finance charge is $3,130.70 and the APR stays 9.62%.
  • Offer D: a rate of 6.49% gives 8.61%.
  • Offer A: 8.99% with no fee gives 8.99%.
  • For A, D and B with the fee borrowed, the “Cost if you repay early” table gives that offer’s column of the early-payoff table: the cost and yearly cost after 12, 24, 36 and 48 payments.
• Loan payment calculator:
  • Offer A: $15,000 at 8.99% for 48 months gives $373.20 a month and $2,913.88 of interest, and row 12 of the schedule shows the $11,737.87 balance used above.
  • Offer B, borrowing $15,625: 7.49% for 48 months gives $377.72 and $2,505.70.
  • Longer terms: a 60-month term at 8.99% gives $311.30; $15,000 at 8.49% for 72 months gives Offer C’s $266.60 and $4,195.31.
• Auto loan calculator: for a car loan, enter dealer fees as financed or paid upfront and choose your sales-tax treatment to see how each changes the amount financed and the payment.
• Refinance calculator: when one option replaces a loan you already have, enter how many months you expect to keep the new loan to compare total cost at that point, as in the early-payoff table.