Difference Between Mortgage Annual Percentage Rate and Interest Rate
When shopping for a mortgage, you’ll likely come across two key terms: annual percentage rate (APR) and interest rate. Although these terms are often used interchangeably, understanding the difference between them can help you choose the best loan option. Here’s the difference between an APR and an interest rate, and why it matters when it comes to your mortgage.
What is the mortgage interest rate?
The mortgage interest rate is the cost of borrowing money for a mortgage. It is usually expressed as a percentage of the total loan amount. You will pay principal and interest to the lender based on the interest rate.
The interest rate does not include down payments and other fees. It represents the current, long-term value of the actual loan amount itself. The higher the mortgage rate, the lower your purchasing power as a home buyer, since a higher interest rate will affect the size of your monthly payments and therefore how much home you can afford. (More on this below.)
What is the mortgage annual percentage rate?
Your mortgage’s APR is the total cost of your mortgage per year, expressed as a percentage. The APR for your mortgage includes the prime interest rate plus any loan origination fees, discount points and other closing costs. So the APR gives a more complete picture of how much you’ll pay each year for your mortgage. This number allows you to more fully compare costs between lenders, since a lower mortgage rate may mask a higher APR if there are many fees charged.
Why does the difference matter?
Simply put, your interest rate is the cost you’ll pay each year to borrow money, while your APR is a more comprehensive measure of the total cost of borrowing money that takes additional fees into account.
Because the APR includes your interest rate and other fees associated with your loan, your APR may reflect a larger number than your interest rate. For example: a loan with an interest rate of 3% and 2 discount points might have an APR of 3.25%. A 0.25% increase in the annual interest rate represents additional borrowing costs. This is why you can consider the APR to be the effective interest rate.
You can also think of APR and APR in terms of their primary purposes: Your APR shows the total annual cost of your mortgage , which will help you compare offers from different lenders. The interest rate, on the other hand, only shows the cost of borrowing the principal amount of the loan, which determines your monthly payments .
Here we explain what a high mortgage rate means for your monthly payments . You can find out how much the current rate will affect your monthly payments by using an online mortgage calculator .
Finally, it doesn’t hurt to ask lenders to explain both rates to you. Comparing the APR helps you determine the best overall loan offer, and knowing your interest rate can help you determine whether you can afford the monthly payments—both are important factors to consider when buying a home. Before you take out a mortgage, make sure you are happy with both the APR and interest rate. What’s more, here are our seven deadly sins when buying your first home .