When shopping for a mortgage, you’ll likely encounter two key terms: Annual percentage rate (APR) and interest rate. While these terms often get thrown around 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 mortgage interest rate?
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The mortgage interest rate is the cost of borrowing money for your home loan. It’s typically expressed as a percentage of the total loan amount. You’ll make principal and interest payments to the lender based on the interest rate.
The interest rate doesn’t include upfront fees and other charges. It represents the ongoing, long-term cost of the actual loan amount itself. The higher the mortgage rate, the lower your purchasing power as a homebuyer, as a higher percentage will impact the size of your monthly payments, and therefor, how much home you can afford. (More on that below.)
What is mortgage APR?
Your mortgage’s APR reflects the total cost of your mortgage loan per year, expressed as a percentage. The mortgage APR includes the base interest rate, as well as any origination fees, discount points, and other closing costs. In this way, the APR provides a more complete picture of how much you’ll pay annually for your mortgage. This number allows you to more fully compare costs between lenders, as a lower mortgage rate could be masking a higher APR if there are a lot of fees involved.
Why does the difference matter?
Simply put, your interest rate represents the cost you’ll pay each year to borrow money, while your APR is a more comprehensive measure of the total cost to borrow money that takes additional fees into account.
Since APR includes your interest rate and other fees connected with your loan, your APR may reflect a higher number than your interest rate. For example: A loan with a 3% interest rate and 2 discount points may have a 3.25% APR. The .25% higher APR represents the added costs to get the loan. This is why you can think of APR to be your effective rate of interest.
You can also think of APR and interest rate in terms of their primary purposes: Your APR shows the total annual costs of a mortgage, which will help you compare deals across lenders. Interest rate, on the other hand, shows just the cost of borrowing the principal loan amount, which drives your monthly payments.
We explain what a high mortgage rate means for your monthly payments here. You can find out how much the current rate will impact your monthly payments with an online mortgage calculator.
At the end of the day, it doesn’t hurt to ask lenders to explain both rates to you. Comparing APR helps identify the best overall loan offer, and knowing the interest rate will help you determine whether you can afford the monthly payments—and both are crucial considerations that go into buying a home. Check that you’re comfortable with both the APR and the interest rate payments before committing to a mortgage. For more, here are our seven deadly sins of buying your first house.