Two loans quoting the same rate can cost noticeably different amounts over their lives. The stated rate is only one input, and the mechanics applied around it do a great deal of the work.
Compounding frequency changes the effective rate
Interest can be calculated and added to the balance annually, monthly or daily, and each addition then earns interest itself in subsequent periods.
More frequent compounding at the same nominal rate produces a higher effective cost, because interest begins earning interest sooner.
This is why disclosure regimes require an annualised figure alongside the nominal rate, so that products with different compounding can be compared on a common basis.
The balance the rate applies to matters
Some products charge interest on the outstanding balance as it reduces, so the interest portion of each payment falls as the principal is repaid.
Others compute the total interest at the outset against the original amount and spread it evenly, which means the borrower keeps paying on money already returned.
The second method produces a considerably higher effective cost than the headline rate suggests, and the difference widens with the length of the term.
Amortisation front-loads the interest
On a level-payment loan, each payment is split between interest and principal, and early payments are weighted heavily towards interest because the balance is largest then.
The proportion shifts gradually, so principal reduction accelerates in the later years while the payment itself stays the same.
This is why the balance on a long loan falls slowly at first, and why the total interest paid depends so strongly on the term chosen.
Fees are part of the cost even when they are not interest
Origination charges, arrangement fees and points are paid at the outset but relate to the credit, so disclosure rules generally require them in the annualised figure.
Where a fee is financed rather than paid separately, it is added to the principal and then attracts interest for the life of the loan.
Charges that fall outside the calculation, such as late fees, do not appear in the quoted figure and only arise from what actually happens during the term.
Timing rules affect the arithmetic quietly
Daily accrual means the date a payment is credited changes the interest charged, so paying earlier in a cycle reduces cost slightly.
Grace periods on revolving accounts remove interest entirely where the balance is cleared in full, but they typically lapse once a balance is carried forward.
How additional payments are applied also matters, since a lender may treat them as advance payments rather than as a reduction of principal unless directed otherwise.