When you're applying for a loan, there are two essential terms that you should be aware of: the interest rate and the Annual Percentage Rate (APR). These terms help you determine how much you'll be paying when you borrow money. In this article, we'll break down the concepts of interest rate and APR as they relate to Earnest student loans and explain why they may differ across repayment plans, even in the absence of origination fees.
Interest Rate: The interest rate is the annual cost to a consumer to borrow money. It is expressed as a percentage and is based only on the amount of money it costs to borrow the principal loan amount. For example, if you borrowed $1,000 on a one-year loan with a 5% interest rate, that loan would cost you $50 in interest.
Annual Percentage Rate (APR): The Annual Percentage Rate (APR) is the cost an individual will pay each year to borrow money, including fees, expressed as a percentage. It includes not only the interest rate but also other factors such as fees (which Earnest does not charge), deferred or reduced payments, capitalized interest, and repayment terms. The APR is intended to provide applicants with a more comprehensive view of the total cost of borrowing money when compared to just the interest rate alone and allows applicants to analyze the costs of loans between lenders under normal repayment conditions.
Generally, when there are no origination fees or costs involved in a loan, the APR will be very similar to, or the same as, the interest rate. This is because there are no additional charges added to the calculation beyond the interest itself, which causes the APR and the interest rate to be the same if the loan is on an immediate repayment plan (i.e., where you start making full principal and interest payments right away). However, with certain student loans, this may not always be the case because the APR calculation may not include factors such as compounding and the accrual of interest when the repayment starts and whether unpaid interest is capitalized (added to your principal balance) after the deferment periods.
Why would the APR be different from the interest rate if Earnest doesn't charge fees?
Because Earnest loans do not include any additional fees or costs, the APR will never be higher than the interest rate. However, it is possible for the APR to be lower than the interest rate when calculated on a loan which includes our deferred or $25 fixed repayment plan. Under these repayment plans, you are not making full principal and interest payments, however, interest continues to accrue on the entire unpaid loan balance and that accrued interest will capitalize at the end of the deferred or $25 fixed repayment plan period. The length of the deferred or $25 fixed repayment plan period and the capitalization of unpaid accrued interest are factored into the APR calculation and cause the APR to appear lower than the interest rate. To better illustrate the impact, here’s an example of a loan with the same loan amount and interest rate calculated under different repayment plans:
| Repayment Option: | Immediate Principal & Interest | Deferred Repayment |
| Loan Amount: | $1,000.00 | $1,000.00 |
| Interest Rate: | 5.00% | 5.00% |
| Deferred Repayment Period: | 0 years | 4 years |
| Grace Period | 0 Months | 9 Months |
| Unpaid Accrued Interest Capitalized: | $0.00 | $237.50 |
| Balance When Principal & Interest Payments Begin: | $1,000.00 | $1,237.50 |
| Principal & Interest Payments Begin: | 1 month from disbursement | 58 months from disbursement |
| Monthly Payment Amount: | $18.87 | $23.35 |
| Repayment Terms: | 5 years | 5 years |
| Total Loan Term: | 5 years | 9 years and 9 months |
| APR: | 5.00% | 4.66% |
| Total Cost of Loan: | $1,132.20 | $1,401.00 |
When you calculate the APR on the deferred example, it would be based on a loan term of 9 years and 9 months (4 years of the deferred repayment plan, plus 9 months of grace period, plus 5 years of full principal and interest payments) instead of 5 years and it would take into account the accruing interest during the deferral period. This results in an APR that is lower than the actual interest rate.
While the APR is a useful tool for comparing loans that include fees, it may not fully represent the true cost of borrowing for deferred repayment plans. During deferment, interest might still accrue on the loan balance, but because no payments are required, the interest may not affect the applicant's immediate financial obligations.
It's important to carefully consider both the interest rate and the APR when evaluating student loan options. While a lower APR might initially seem appealing, keep in mind that the interest accruing during the deferral period will contribute to the overall cost of the loan. Per federal regulations, we are required to display the APR on marketing material. While the APR may adjust depending on your confirmed repayment start date, the Loan Approval Disclosure and Final Disclosure must disclose the loan's interest rate without any modifications, such as discounts.
We encourage you to review your Loan Approval Disclosure, loan agreement, and Final Disclosure thoroughly. If you have any questions, please don't hesitate to reach out to our Client Happiness team by clicking the "Get In Touch" button at the bottom of this page.