APR Vs. Interest Rate: What’s The Difference?

Both APR and Interest Rate are the terms that are used for describing the cost of borrowing money from your mortgage lender. While these numbers are somewhat related, they are not exactly the same. Here’s what you need to know about them to make an informed decision about your mortgage loan or a refinance.

Mortgage APR vs. Interest Rate

• Annual Percentage Rate (APR): An APR is the annual cost of a loan to the borrower, which includes mortgage fees as well. An APR is expressed as a percentage of your loan amount. But unlike interest rate, the APR includes other fees as well such as closing costs, mortgage insurance, loan origination fees, and discount points.
• Interest Rate: The interest rate is the cost of borrowing the principal loan amount. The interest can be fixed or variable (varies over the loan term), but is always expressed as a percentage.

Difference Between APR and Interest Rate

Both the APR and the interest rate are a way for borrowers to compare the loan costs under varying circumstances and determine the affordability of the loan. The interest rate is determined by the market rates and the borrower’s credit score.

On the other hand, APR is determined by the lender since it includes lender’s fees and some other costs that vary from lender to lender. The Federal Truth in Lending Act requires that APR is disclosed for every consumer loan agreement. Since this is a standard procedure and every lender uses the same rules and metrics to ensure the accuracy of the APR, borrowers can use it as a good basis to compare and analyze certain costs of the loan.

However, know that your monthly mortgage payments are determined by the interest rate on your loan and not the APR. You can think of an interest rate as a way to gauge your monthly payments while APR gives you a bigger picture by estimating the overall cost of the loan.

Another important thing to note is sometimes lenders do not include all fees in the APR. For example, they are not required to add inspection fee, appraisal costs, and credit reporting. So, it is worth checking what’s included in your APR when you compare costs of different loans in order to have an accurate understanding of how much each loan option will cost.

Bottom Line

If you plan to stay in your home for years or decades, it makes sense that you choose a loan that comes with the lowest APR as you will end up paying the minimum to finance your home. But if you don’t plan to stay in your home for a long time, it may make sense to pay fewer upfront fees and get a higher rate with higher APR, because you will end up paying less for the first few years.