If you’re in the market for a home loan, you’ve likely come across “interest rate” and “annual percentage rate” when referring to a mortgage. Interest rate and APR are often used interchangeably, but they’re different.
Buying a home is expensive, and taking on debt to own that home is serious business. By understanding the difference between APR and interest rate, you can accurately calculate what you owe, compare loan offers and budget your monthly payment and upfront costs.
APR vs. interest rate
- Interest rate: An interest rate is the percentage of a home loan you pay a lender to borrow money, excluding other costs to take out a mortgage.
- Annual Percentage Rate: An APR includes your interest rate and other fees, creating a more accurate picture of the true cost of your home loan.
What is an interest rate on a mortgage?
Your interest rate is the cost of borrowing money from a lender, expressed as a percentage, whether for a variable or fixed-rate mortgage. Your interest rate does not include any additional fees tacked on to the mortgage cost.
How are mortgage interest rates calculated?
Broadly speaking, mortgage interest rates are determined by a combination of external market conditions: Inflation, financial markets, investor expectations, political events and the government’s monetary policy.
Though the Federal Reserve doesn’t directly set mortgage rates, the Fed’s monetary decisions affect the interest rates you pay as a borrower. For instance, when the central bank increases short-term interest rates, it becomes more expensive for banks and mortgage lenders to borrow money, creating a domino effect for mortgage loans. On the flip side, when the Fed lowers short-term interest rates, mortgage rates tend to decrease alongside.
The particular mortgage interest rate you receive is also affected by your personal finances, particularly your credit score, debt-to-income ratio and loan-to-value ratio (the size of the loan compared to the value of the home). Mortgage lenders may give you a lower interest rate if you have an excellent credit score and a low debt-to-income ratio.
What is an APR on a mortgage?
Your loan’s APR represents your interest rate plus a combination of additional fees. Because an APR includes more than just the interest, they’re typically higher than interest rates. Some fees that may be incorporated into the APR are:
Closing costs: When you close on your home loan, these costs are usually 3% to 6% of the mortgage amount.
Loan origination fees: Also known as underwriting costs, you’ll pay these processing fees to the lender, which are usually 0.5% to 1% of the loan amount.
Discount points: By paying for mortgage discount points upfront, you can save money with a lower interest rate over the life of the loan, but the cost will be included in closing.
Document preparation fee: The fee for administrative costs of your loan can be anywhere from $50 to $100, depending on the lender.
Broker fees: A broker’s commission can vary, but generally ranges from 0.50% to 2.75% of the mortgage loan.
Private mortgage insurance: If you put down less than 20% of your down payment, you’ll be required to pay private mortgage insurance. The monthly average cost of PMI can be anywhere from 0.46% to 1.5% of the loan amount.
How is a mortgage APR calculated?
Two mortgage loans with the same interest rate are bound to have different annual percentage rates, depending on their loan terms and other factors. While you may not be able to negotiate your interest rate, you may be able to negotiate some of the other costs included in your APR.
Calculating APR on a mortgage requires the loan amount, term and interest rate to start. You’ll also need to include the amount for origination fees, broker fees, mortgage discount points and other figures. Though you can try the math on your own, your lender will provide this information to you.
You can also plug the information into an online calculator, such as Bankrate’s APR calculator. If you have a loan amount of $300,000, a 30-year term, a 7.8% fixed interest rate and you’re paying a total of $7,000 in closing costs, for example, your APR will be 8.04%.
Comparing mortgage interest rate vs. APR
Here’s an example of the difference between an interest rate and an APR on a $300,000 mortgage on a $350,000 home, factoring in different fees:
| 15-year fixed mortgage | 30-year fixed mortgage | |
| Interest rate | 7.3% | 7.3% |
| Loan origination fee | 0.5% | 1.0% |
| Other closing costs | $5,000 | $7,000 |
| APR | 7.65% | 7.63% |
How does a loan term affect APR and total interest?
Typically, the longer the term length, the more you’ll pay in interest over the lifetime of a loan, though you’ll have a smaller monthly mortgage payment. The shorter the term length, the less you’ll pay in interest, but your monthly payments are higher.
Here’s an example of how a term length can impact your APR and total interest, based on a $300,000 mortgage:
| Option A: 7.3% interest rate | Option B: 7.3% interest rate | Option C: 6.6% interest rate | Option D: 6.6% interest rate | |
| Loan term | 15 years | 30 years | 15 years | 30 years |
| Closing costs | $10,000 | $10,000 | $10,000 | $10,000 |
| APR | 7.84% | 7.63% | 7.13% | 6.92% |
| Monthly payment | $2,707 | $2,057 | $2,930 | $1,916 |
| Total interest | $194,469 | $440,420 | $173,372 | $389,749 |
The bottom line
While an APR and interest rate will both help you figure out the total cost of a mortgage loan, the APR will give you a more accurate view of what you’re required to pay. Lenders charge different loan fees and advertise different interest rates. By comparing loan offers, you can get a complete view of your costs when buying a home.
FAQs
The interest rate represents the amount of interest charged by your lender to let you borrow money. Because the annual percentage rate includes certain costs and fees like mortgage points, the APR is typically higher than the interest rate. The APR can be the same as an interest rate only if there are no additional fees.
Generally, it’s a good idea to use the APR for shopping for a mortgage. The APR gives you a better idea of the total yearly cost of the loan.
This depends. A lower interest rate can equate to lower monthly payments, but the total cost of the loan might be higher. A lower APR typically means a lower total cost, but your monthly payments might be more expensive.
Due to the Truth in Lending Act, or Regulation Z, the lender is required by law to disclose information on all the fees linked to a loan. Lenders are mandated to provide two sets of written disclosures that include the APR and other fees: the loan estimate and the closing disclosure.
No, interest rates don’t work in the same way with an adjustable rate mortgage. The rate you get with an ARM is an introductory rate for a set period of time. After the introductory term ends, a variable rate kicks in. This means that the annual percentage rate of an ARM won’t give you the total cost of the loan.
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