What are the Differences Between Your Mortgage Interest Rate and APR?

Estimated reading time: 7.5 minutes

Choosing the right mortgage for your home financing needs isn’t just about finding the lowest interest rate. Your annual percentage rate (APR) helps you understand the true cost of your loan.

While your interest rate affects your monthly payment, APR reflects the combined cost of certain fees and interest over the long-term life of the loan. Although they sound similar, learning the differences between your interest rate and APR can help you make an informed home financing decision.

What is an Interest Rate?

Your mortgage interest rate shows the base price you pay to borrow money. It’s thought of as being the base cost of your loan.

Monthly mortgage payments often consist of four components: principal, interest, taxes, and insurance (PITI). However, only the principal and interest are part of the loan itself.

The principal is the base amount of money you are borrowing for your loan. As a borrower, you are responsible for paying back your loan’s principal and interest. Your mortgage payments are amortized, meaning each monthly payment is divided between paying down your mortgage principal and your interest.

Your interest rate may be fixed, meaning it stays the same over the life of your loan, or adjustable. With an adjustable-rate mortgage (ARM), your interest rate is only fixed initially. One the fixed period expires, your interest rate adjusts periodically based on a predefined index and margin, according to the terms set before closing.

What Impacts Your Mortgage Interest Rate?

Your mortgage interest rate is determined by a combination of factors, some that are in your control and others that aren’t. Below are some factors that a borrower has control over.

Your Credit Score

Your credit score is one of the biggest factors in determining your mortgage affordability. Before you apply for a mortgage, be sure your credit is ready by making payments on time, keeping your credit history, and resisting hitting your credit limit. A higher credit score is a signal to lenders that you have a history of paying back your loans.

Debt-to-Income Ratio

Also known as DTI, your debt-to-income ratio compares how much money you owe (your debts) to how much money you earn (your income). Unlike your credit score, a lower ratio is a signal to lenders that you have a healthy balance between your debt and income. Avoiding new debt or increasing your income are both great ways to improve your DTI.

Down Payment Percentage

Your down payment is the upfront money you pay to purchase your home. The amount necessary depends on the loan program you choose. It also affects your loan-to-value ratio, which is a calculation used by lenders to determine how much risk they are taking on for issuing a loan. The higher a borrower’s loan-to-value ratio, the riskier the loan is for a mortgage lender if the borrower defaults on their loan.

What is APR?

APR, an abbreviation for annual percentage rate, is the yearly measurement of your loan’s interest rate and any additional costs associated with receiving your loan. This can include any origination fees, closing costs, private mortgage insurance (also known as PMI), or discount points. Your APR can be higher than your mortgage rate because of the additional included costs.

An Example of APR Versus Interest Rate

Imagine you’re shopping for a mortgage lender for your new home purchase. You find two lenders that are offering you the same rate, but the APR for each loan offer varies. Both lenders offer you a 30-year fixed rate mortgage at the same rate of 6.50%. At first glance, a borrower may assume that they are spending the same amount of money from each lender. However, the loan’s annual percentage rate will detail any additional loan costs and fees.

Imaginary mortgage lender A presents an interest rate of 6.50% with an APR of 6.62%. By using lender A, you would be paying $1,200 in upfront lender fees. Imaginary mortgage lender B presents a 6.50% interest rate with an APR of 6.85%. Lender B’s APR is higher because their upfront lender fees are $4,500.

These figures are for illustrative purposes only.

So, What are the Significant Differences Between Your Interest Rate and APR?

Your APR and interest rate are alike to one another. They both inform a borrower about the cost of borrowing money from a lender. Both are represented as percentages and reflect whether the underlying loan has a fixed or adjustable interest rate.

Your APR and interest rate work in tandem together. After all, your mortgage interest rate is included in your APR.

While both percentages are helpful, they also answer different questions. Whereas your interest rate can help you understand your overall monthly costs, APR helps you compare the overall cost of different loan options and programs. The inclusion of both percentages on your loan estimate will help you determine the full cost of your overall loan.

Should You Pay Attention to Your Loan’s Interest Rate or APR?

You should pay attention to both your loan’s interest rate and the APR. In fact, as your interest rate is part of your APR, paying attention to both percentages ensures you’re understanding the bigger picture of affordability and costs.

Under the Truth in Lending Act (TILA), lenders are required to disclose APR on standardized documents, such as the loan estimate. This allows borrowers to compare loan offers.

What Are Common Misconceptions About APR and Interest Rates?

Your APR is the Same, Regardless of Your Mortgage Lender

As your APR is the combination of your loan’s interest rate and costs associated with borrowing money, your annual percentage rate will not be the same for every mortgage lender.

APR Does Not Affect First-Time Homebuyers

Both mortgage interest and APR affect all homebuyers, no matter what their first-time buying status is. By working with a Licensed Loan Originator, a borrower can examine both percentages and receive expert advice about the breakdown of costs.

You Only Need Your Interest Rate to Compare Mortgage Lenders

While you may be able to get a lower interest rate from another mortgage lender, the true cost of your loan and associated fees will be laid out in your annual percentage rate. A mortgage lender may have higher lending fees and closing costs than another lender.

Helping You Demystify the Mortgage Process

When you are deciding on your choice of mortgage financing, it isn’t about finding the lowest number. It’s more important to understand what those numbers represent. Your loan’s interest rate and APR each highlight different aspects that lead to an understanding of its overall cost. Using both numbers as part of your decision-making process can help you feel more confident.

Work with a Licensed Loan Originator who will help walk you through the details of your loan costs and answer your questions along the way. Contact us to get started.