APR vs. interest rate: What’s the difference? If you’re applying for a mortgage, these are two financial terms you need to understand. APR stands for “annual percentage rate,” or the amount of interest on your total loan that you’ll pay annually over the life of the loan. It’s slightly different from the interest rate, which is the cost you’ll pay each day based on your mortgage balance.
These terms might be foreign to you, especially if this is your first time buying a home. But don’t worry—we’ll break down what each one is so that you’re ready to be a savvy mortgage shopper. Let’s first start by discussing the mortgage interest rate.
What is a mortgage interest rate?
Simply put, the interest rate is the cost you will pay each day the borrowed money is owed, expressed as a percentage rate. In other words, “it does not reflect fees or any other charges you may have to pay for the loan,” says Staci Titsworth, regional manager of PNC Mortgage in Pittsburgh.
Interest is calculated as a per diem (per day) figure based on the borrower’s current outstanding mortgage balance. This means that every month you pay back a portion of the principal (the amount you’ve borrowed) plus the interest accrued for the month. Your mortgage lender will use an amortization formula to create a payment schedule that reflects your principal and interest on the loan.
What determines my mortgage interest rate?
Like gas prices, mortgage rates can fluctuate from day to day depending on changes in housing market conditions, says Jack Guttentag, author of “The Mortgage Encyclopedia.” But even saving a fraction of a percent on your interest rate can save you thousands of dollars over the life of your mortgage.
Six key factors affect your interest rate:
What is an APR?
There are costs to obtaining a mortgage, says Jordan Dobbs, a loan officer at Washington First Mortgage in Rockville, MD. In a nutshell, Dobbs says, an APR is a broad measure of the cost to you of borrowing money, expressed as a percentage rate. It determines the total amount you pay annually over the life of the loan.
What determines my APR?
Because APR includes the interest rate offered on your mortgage, as well as discount points, mortgage origination fees, and other costs associated with obtaining a loan, it is usually higher—often 0.20% to 0.25% greater—than the interest rate. So, in general, the higher your APR, the higher your payments are over the life of your home loan.
Consequently, “it’s important to check both interest rate and APR when looking for a mortgage,” says Dobbs. If you’ve applied for a mortgage and received a good-faith estimate from a lender, you can find the interest rate on Page 1 under “Loan Terms,” and the APR on Page 3 under “Comparisons,” according to the Consumer Financial Protection Bureau.
APR vs. interest rate: Things to keep in mind
Pro tip: When lenders advertise APRs, they offer the rates under ideal conditions—meaning rates apply to borrowers with excellent credit and spotless documentation. Depending on your circumstances, the rates can be higher.
Moreover, lenders that offer low APRs often require high upfront fees; their points requirements, origination fees, and insurance payments might be unusually high in order to justify their lower rates.