ljubaphoto/Getty Images: Illustration by Isiah Davis/Bankrate
When shopping for a mortgage, it can be difficult to know how to truly compare apples-to-apples. Understanding the difference between loan interest rates and annual percentage rates (APRs) can help you be a smarter mortgage shopper and potentially save you money in the process.
What is the Difference Between APR and Interest Rate?
keyword
- interest rate
- The amount you pay for borrowing on a mortgage expressed as a percentage of the principal amount loaned.
- Annual Percentage Rate (APR)
- A percentage that shows the total yearly cost of a loan, including not only interest but also other fees paid by the mortgage.
A mortgage’s annual percentage rate (APR) and interest rate are both expressed as a percentage and serve as benchmarks for comparing different loans and their costs. The key difference is that the interest rate will always be lower than the APR.
If you take out a 30-year fixed-rate mortgage of $300,000 at a 7 percent interest rate, you’ll pay a 1 percent origination fee ($3,000) plus a 1-point mortgage fee (another $3,000) for a total of $6,000 in fees. These additional costs bring your APR to 7.197 percent.
Interest Rates and APRs
Here’s a breakdown of the difference between APR and interest rates:
interest rate
- The borrowing cost that the lender applies to the principal amount loaned.
- It does not reflect any other costs or fees paid in connection with the loan.
- Affected by the Federal Reserve’s interest rate policy
April
- Costs, including interest on the loan and any additional fees charged as part of the loan, such as origination fees
- A more accurate reflection of the overall cost of your mortgage
- Usually more expensive than interest only
The Truth in Lending Act (TILA) requires mortgage lenders to disclose the APR and interest rate of a loan to borrowers. This information is included in the Loan Estimate and Closing Disclosure, which includes the closing costs and terms of the loan. It’s important to note that lenders may not include all fees in the APR. They aren’t required to include certain costs, such as credit report or appraisal fees. When comparing offers, ask your lender what’s included in the APR so you know exactly how much your loan will cost.
What is the interest rate?
Mortgage interest rates reflect the cost you pay to buy a home. For example, say you take out a $340,000 30-year fixed-rate mortgage at a 7 percent interest rate. If you borrow at this rate for 30 years, you’ll pay $474,330 in interest on top of the $340,000 in the loan.
This seems like a lot, but in this example, you’ll make the same mortgage payment each month, with part of that payment going toward the $340,000 you borrowed (the loan principal) and another part going toward interest. At the beginning of the loan, you’ll pay less toward principal and more toward interest. As the loan amortizes, your payments gradually start to pay more toward principal and less toward interest.
How is interest calculated?
Interest rates are determined in part by factors that are completely outside of your control, like inflation, the overall state of the economy, and your choice of lender. These factors cause mortgage interest rates to constantly change. Every time interest rates increase, it affects the amount of home you can afford. This is why locking in a mortgage rate can be a valuable tool when buying a home.
The specific interest rate on your mortgage will be based on your credit history and credit score, your debt-to-income ratio (DTI), down payment plans, and other financial considerations. Generally, the higher your credit score, the lower your interest rate.
To get the lowest possible rates, here are some ways to do it:
- Buy mortgage points
- Improve your credit score
- Pay a larger down payment
- Pay off or eliminate high-interest debt
- Obtaining a first-time homebuyer loan (if you qualify)
What is APR?
APR stands for Annual Percentage Rate. It represents the cost of your mortgage and includes interest and other fees, such as:
How is the APR calculated?
There are three main numbers that come into play when determining your mortgage APR: the interest rate, the fees, and the points you pay up front. You can use Bankrate’s APR calculator to get an idea of how different fees and points affect the overall cost of your loan.
Mortgage interest rates and APR examples
Below is an example comparing APRs and interest rates on a $300,000, 30-year fixed rate mortgage.
| interest rate | 6.8% | 6.95% | 7% |
|---|---|---|---|
| commission | 1% ($3,000) | 1% ($3,000) | 1% ($3,000) |
| Discount points | 2 ($6,000) | 1 ($3,000) | 0 |
| Points and fees | $9,000 | $6,000 | $3,000 |
| April | 7.021% | 7.173% | 7.224% |
| Monthly payment (principal and interest) | $1,956 | $1,986 | $1,996 |
| Total Interest | $404,075 | $414,907 | $418,524 |
Tips for comparing interest rates and APRs
- The APR gives you a more accurate idea of the actual cost of your loan. APR includes fees, so comparing APRs will tell you exactly how much you’ll pay.
- Compare loan offers before choosing a lender. Some lenders advertise low interest rates but charge high upfront fees, while others offer higher interest rates but don’t charge fees. Taking the time to research mortgage lenders and compare offers could save you money over the life of your mortgage.
- Be careful with comparisons Fixed and variable interest rate mortgages. The interest rate offered on an ARM is an introductory rate and is only fixed for a set period of time, meaning that after that period your interest rate may increase and so will your payments. With a fixed-rate mortgage, your interest rate remains constant, so your principal and interest payments remain the same each month.
- The APR on an ARM does not reflect the maximum interest rate on the loan. After the introductory rate ends, your interest rate may increase significantly depending on the market and the interest rate cap of your ARM. Learn more about how ARMs work here.
