When it comes to borrowing money, interest is typically charged on what you borrow. But interest comes in various forms, like APR and AIR. While they both measure interest, APR gives you the full cost of borrowing, whereas AIR just focuses on the interest charged. Knowing the difference can save you money and confusion when comparing loans. Let’s go into more detail about APR and AIR to help you become a more informed borrower.
Key Points
- The AIR is the basic cost of borrowing and estimates how much interest you’ll pay per year on a specific loan amount.
- The APR goes further and includes the interest rate plus additional fees and charges, making it a more complete picture of borrowing costs.
- The length of your loan term affects interest: the longer the term, the more interest you may pay overall, making the APR and AIR key factors in understanding the true cost of borrowing over time.
What Is AIR?
Short for “Annual Interest Rate”, AIR refers to the estimated amount of interest that you would pay yearly to borrow a specific amount of loan principal, like you would see with a personal loan or mortgage. Your AIR is displayed as a fixed or variable percentage and is typically calculated as follows:
| Total Interest ÷ Loan Amount ÷ Length of Repayment Term |
While most lenders use Annual Percentage Rate (APR) when comparing the cost of different loan products, it doesn’t always produce as accurate of a figure as Annual Interest Rate (AIR) does, particularly when it comes to installment-based loans.
Otherwise, known as a “declining balance loan”, installment loans involve a set sum, which gets lower whenever you make a payment. Your lender should only charge interest on the balance that remains. If your rate is “fixed”, it won’t change throughout your loan term and if it’s “variable”, it fluctuates with Canada’s prime borrowing rates.
What Is APR?
To truly understand AIR, you must also learn about APR, which represents the annual interest rate that lenders charge you to borrow from them. It’s charged on a yearly basis as a percentage of your loan principal.
Unlike AIR, however, APR is calculated using different criteria:
- Loan’s periodic interest rate (rate charged per month)
- Total loan principal
- Size of your monthly loan payments
- Number of days in your repayment term
- Fees and interest charged over the life of the loan
- Any discounts that can be applied
The formula for APR is as follows:
| [ (Fees + Interest) ÷ (Principal) ÷ (# of Days in Term) x 365 ] x 100 |
Common Loan Types That Involve APR
There are several types of APR that lenders apply to different financial products, like the following:
- Credit cards
- Cash advances
- Lines of credit
- Investment accounts (to determine the annual rate an investor earns without compounding interest)
Learn more: Interest Rates 101
How To Calculate AIR Vs APR
Remember, the AIR represents the percentage of the loan principal that a lender charges annually. APR is similar, in that it uses the total amount of interest that you have to pay each year; however, it encompasses all costs involved with the loan.
Calculating AIR
As mentioned, your AIR is calculated by taking the total yearly interest your lender charges you, dividing it by your loan amount, then dividing that number by the length of your repayment term. Let’s illustrate using the above equation:
Formula: Total Interest ÷ Loan Amount ÷ Length of Repayment Term
| Example: $5,000 of interest on a $50,000 personal loan, with a 2-year term $5,000 ÷ ($50,000 ÷ 2) = 0.05 or 5.00% AIR |
Keep in mind that this is just a simplified calculation. When your lender actually assigns your AIR, their decision will be based on other factors, like your income, credit score and debt level.
The better your financial health is overall, the less risk you have of defaulting on your loan payments in the future. As a result, the lender may offer you a larger loan with a lower AIR and a longer term.
Calculating APR
To give you a better idea of how APR works, let’s apply the formula shown above to the same example (a $50,000 loan with $5,000 interest and a 2-year term). Only this time, we’ll add a 1% ($550) origination fee:
Formula: ((Fees + Interest) ÷ (Principal) ÷ (# of Days in Term) x 365) x 100
| Example: (($550 + $5,000) ÷ $50,000 ÷ 730) x 365 x 100 = 5.55% APR According to these figures, your monthly payment should be $2,206 |
Essentially, while AIR reflects your yearly interest rate, APR may show the true cost of borrowing, since it factors in all the costs associated with your loan/credit product. The length of your loan term also matters greatly, because a longer term generally leads to a lower APR. Plus, there’s always the chance that you manage to pay your loan off early.
Differences Between AIR & APR
As you can see, the Annual Percentage Rate is slightly higher than the Annual Interest Rate above. However, don’t forget that your loan balance will be “declining” and your lender should only charge you interest on the unpaid principal remaining. Due to this confusion, many lenders have started using AIR to calculate the true cost of a loan.
What’s More Important: A Lower APR Vs A Lower Yearly Rate (AIR)?
These days, most lenders will use a combination of AIR and APR to tally up the total cost of your loan. Then again, there are specific circumstances where either type of rate could be considered “better” than the other. For instance:
- AIR: Your Annual Interest Rate produces more accurate results than APR when calculating your yearly interest rate and the initial size of your monthly payments. It fluctuates according to your lender’s current rates, as well as your financial health. The stronger your income and credit are, the lower your rate will be.
- APR: While your Annual Percentage Rate offers a broader percentage that’s set by the lender, it’s a simpler way of calculating the yearly cost of loan, as it takes other factors into account, including discounts and fees. By law, all lenders must display their APR (but not necessarily all their fees) on their loan agreements.
APR Vs AIR: Why Does The Length Of Your Loan Term Matter?
When you take out a loan, is it better to have a lower AIR with a higher APR or a higher AIR with a lower APR? The answer can depend on a number of things, but one of the most significant is the length of your repayment term.
- High APR & Low AIR: Generally, a shorter repayment term leads to a higher APR because the lender has to maximize profit over a shorter period. However, loans with higher APRs often come with fewer upfront fees. This way, you might have a lower AIR overall (especially if you pay off your loan ahead of schedule).
- Low APR & High AIR: Many borrowers opt for longer repayment terms, which come with lower rates and sometimes discount points. That said, longer terms result in extra work for the lender, meaning additional fees (APR) will apply. While you may have smaller monthly payments, your AIR will be higher.
To see how the length of your loan term affects your APR and AIR, check out the table below. Once again, we’ll use the same $50,000 personal loan with a 1% origination fee, only we’ll change up the interest rates and add $1,000 in extra fees per 5-year block.
| Loan Amount | $50,000 | $50,000 | $50,000 |
| Loan Term | 5 years | 10 years | 15 years |
| Interest Rate | 5.50% | 5.00% | 4.50% |
| APR | 6.73% | 6.58% | 6.56% |
| Estimated Fees | 1% + $1,000 = $1,500 | 1% + $2,000 = $2,500 | 1% + $3,000 = $3,500 |
| Monthly Payment | $955.06 | $542.63 | $408.54 |
| Total Principal | 60 x $955.06 = $57,303.60 | 120 x $542.63 = $65,115.60 | 180 x $408.54 = $73,537.20 |
Learn more: How To Get A Long-Term Loan In Canada
What Are Today’s Interest Rates In Canada?
Interest rates on various loan types in Canada fluctuate based on several factors, including the following:
- Bank of Canada’s policy rate
- Inflation trends
- Government bond yields
- Economic conditions
- Housing demand (for mortgages)
- Creditworthiness of the borrower
Check out the following links to find out current interest rates on various loan products:
- Payday Loan Interest Rates In Canada
- Personal Loan Interest Rates In Canada
- Line Of Credit Rates In Canada
Final Thoughts
Interest rates and APR/AIR might seem like complicated financial terms, but they affect most aspects of your financial life. Get informed about interest rates and other financial terms, and your finances will thank you later.
