Which statement best distinguishes between the interest rate and APR?

• A. The interest rate is the base cost; APR includes points and fees, reflecting the annual cost
• B. APR is the base cost; Interest rate includes fees
• C. They are the same
• D. Interest rate includes closing costs; APR excludes them

Answer: (A)

The main idea is that the interest rate shows the base price of borrowing, while the APR represents the true annual cost when you include up-front and financed costs. The interest rate determines how much interest accrues each year and drives the regular monthly payment. The APR, however, adds in points, origination fees, and certain other closing costs, then spreads those costs over the loan term to show an annual cost percentage. This is why, even if two loans have the same interest rate, the one with higher upfront fees will have a higher APR.

So the statement that the interest rate is the base cost and APR includes points and fees, reflecting the annual cost, is the best description. The other ideas—saying APR is the base cost, saying they’re the same, or saying the interest rate includes closing costs—don’t fit because APR and the interest rate measure different pieces of the borrowing cost, and APR should capture the extra charges to allow a fair comparison.