Quick primer

When you shop for a loan, lenders may quote APR, EAR, or both. APR (Annual Percentage Rate) is intended to show the yearly cost of borrowing including many lender fees; EAR (Effective Annual Rate), sometimes called the effective yield, shows the real percentage you effectively pay after compounding during the year. Both numbers matter but for different reasons.

I’ve worked with clients who picked loans based only on the lowest APR and later discovered higher effective costs because of frequent compounding or undisclosed fees. Knowing how to read and convert these rates prevents surprises and lets you compare offers apples-to-apples.

Why the difference matters

  • APR helps compare offers that include fees. It’s useful when loans have upfront or recurring charges that change the effective cost beyond nominal interest.
  • EAR captures the time-value effect of interest compounding (monthly, daily, etc.). A loan with a low nominal rate but frequent compounding can produce a higher EAR—and thus a higher actual cost—than a loan with less frequent compounding.

Authoritative resources explain these distinctions: the Consumer Financial Protection Bureau (CFPB) guides consumers on APR and loan costs (consumerfinance.gov), and central bank primer material explains compounding’s effect on effective rates.

How to convert APR to EAR (formula and example)

Formula: EAR = (1 + APR/n)^n – 1, where n = number of compounding periods per year.

Example: A loan with APR = 6.0% compounded monthly (n = 12).

  • Convert APR to decimal: r = 0.06
  • EAR = (1 + 0.06/12)^{12} – 1
  • EAR = (1 + 0.005)^{12} – 1 ≈ 1.061678 – 1 = 0.061678 → 6.1678%.

So an APR of 6% with monthly compounding corresponds to an EAR ≈ 6.17%.

Note: Many lenders report APR as a simple annualized percentage that already reflects certain fees, so the formula above applies to converting a nominal interest rate (sometimes labeled APR or nominal APR depending on lender disclosure) to EAR. Always clarify whether the lender’s APR is a nominal rate with stated compounding frequency or an APR that already incorporates fees.

Worked loan comparison: APR vs EAR in practice

Scenario A: Loan 1 — 5.9% APR, monthly compounding, no origination fee.
Scenario B: Loan 2 — 5.7% APR, annual compounding, $300 origination fee on a $10,000 loan.

Step 1 — Convert APR to EAR for compounding effect only

  • Loan 1 EAR = (1 + 0.059/12)^{12} – 1 ≈ 6.06%.
  • Loan 2 EAR = (1 + 0.057/1)^{1} – 1 = 5.70%.

Step 2 — Adjust Loan 2 for the $300 fee by calculating APR-equivalent or comparing total cost

  • Upfront fee reduces net proceeds. Effective loan proceeds = $9,700; payments are based on $10,000. This raises the effective interest paid relative to funds received.
  • Compute total payments for both loans over the same term and compare total dollars paid; the lower-total-cost loan is the better deal even if APR/EAR individually look different.

Takeaway: A slightly lower APR can be offset by fees or frequent compounding. Total dollar costs and EAR-adjusted rates give the clearest comparison.

When to prioritize APR vs EAR

  • Use APR when you want to compare loans that include fees (e.g., many consumer loans, mortgages with origination points). The CFPB requires APR disclosures for many consumer loans to aid comparison.
  • Use EAR when compounding frequency materially affects cost (credit cards, some business loans, deposit accounts, and certain variable-rate products).
  • For short-term loans (weeks or months), calculate total cost in dollars rather than relying solely on APR or EAR.

Common lender disclosures and pitfalls

  • Some lenders quote a ‘‘nominal APR’’ that excludes certain fees; read the fine print and request the full Truth-in-Lending disclosure (for many consumer loans) or equivalent statement.
  • Credit cards typically show a periodic rate and APR. Because interest compounds daily on many cards, compute the EAR if you carry a balance (see card agreement for compounding frequency).
  • Mortgage APRs include certain fees but not all closing costs; similarly, APR doesn’t capture future changes on variable-rate loans.

Practical checklist to compare loan offers

  1. Request the APR, EAR (or compounding frequency), and an itemized schedule of fees.
  2. Compute EAR from the nominal rate if compounding frequency is provided.
  3. Calculate total dollars paid over the loan term (principal + interest + fees). For installment loans, use the amortization schedule; for revolving credit, estimate based on projected balances.
  4. Compare total cost and monthly payment—decide which metric matters more for your budget.
  5. Ask lenders to run an example amortization for your exact loan size and term.

Frequently asked questions (short answers)

  • Can APR and EAR be the same? Yes—if interest compounds once per year and there are no additional fees, APR (as a nominal rate without added fees) and EAR will match.
  • Which matters more for mortgages? Both: compare APR for fee-inclusive comparisons, but check EAR (or effective cost) if compounding or payment timing differs among offers.
  • Do credit cards use EAR? Many use daily or monthly compounding; convert the card’s periodic rate to EAR to understand effective cost if you carry a balance.

Negotiation and decision tips (from practice)

  • I tell clients: ask for a written loan example showing total payments and the amortization schedule. Lenders often can adjust fees, discount points, or compounding options when they want your business.
  • For business loans, run a cash-flow projection using the loan’s payment schedule—sometimes slightly higher rates with flexible repayment terms produce better cash-flow outcomes.

When APR or EAR won’t tell the whole story

  • Variable-rate loans: both APR and EAR can change as rates reset; evaluate scenarios using projected rate paths.
  • Prepayment penalties, balloon payments, or stepped fees: these can materially change effective cost even if APR looks competitive.

Helpful resources and further reading

  • Consumer Financial Protection Bureau: guide to APR and loan cost comparisons (https://www.consumerfinance.gov/) — for required disclosures and consumer guidance.
  • Federal Reserve education materials on interest rates and compounding (federalreserveeducation.org) — for background on how compounding changes effective yields.

Internal resources on FinHelp

Professional disclaimer
This article is educational and does not substitute for personalized financial advice. For decisions about a specific loan, consult a qualified financial advisor, CPA, or attorney who can review your contract and financial situation.

Final thought
Don’t rely on a single number. Use APR to compare fee-inclusive cost and EAR to understand compounding’s impact. Run total-cost calculations and ask lenders for amortization schedules so you can make decisions based on dollars and cash flow—not just percentages.