Mortgage interest rates and APRs are similar, but not the same. The interest rate is how much you'll pay each year on the loan, calculated as a percentage of the amount you owe. The APR represents the total cost of the loan, including closing costs and other upfront fees. If interest is the only cost associated with the loan, the APR will equal the interest rate. Since it's a truer measure of cost, lenders are required to disclose the APR.
Learn more about APR vs. interest rate plus how they can affect which mortgage offer you choose.
Interest rate: What it is and how it's calculated
An interest rate indicates how much you’ll pay to borrow money on an annual basis. It’s a percentage of the amount you owe. To make interest payments affordable, most lenders spread them out over the entirety of the loan — this is called amortization. So, when you make your monthly payment on a mortgage, part of it includes interest.
Since most loans are amortized, your monthly payment stays the same (on a loan with a fixed interest rate) — but the amount of interest paid is recalculated each month based on the remaining loan balance. In the beginning stages of the loan, the portion of the payment going to interest is greater. This is because you haven't had a chance to pay down the balance yet. But as the loan's term progresses, more of the monthly payment goes toward paying down the principal loan amount.
It’s not a simple calculation, so a great mortgage calculator or amortization table can help you see how this works. For example, if you have a $400,000 fixed 30-year mortgage at an interest rate of 6.49%, you’ll see a payment of $2,526 for principal and interest each month.
In the first month, $362 goes toward the principal and $2,163 goes toward interest. In the second month, the interest is calculated the same way, but the amounts going to interest and principal change with the balance reduction from the previous month’s principal payment.
At the end of the loan, more of the monthly payment goes to the principal.
Editor insight: “If you're getting a mortgage for the tax benefit of the mortgage interest deduction, bear in mind that the interest you pay, and therefore the amount you can deduct, will decrease year after year. In turn, this could increase your tax burden and impact how well you can afford your mortgage payment (and other expenses).”
— Meredith Mangan, Senior Loans Editor, Credible
Why your interest rate matters
The interest rate is a crucial part of your loan due to how drastically it can affect your finances. You’ll pay significantly more over the life of your loan when your interest rate is higher. You also qualify for a smaller loan when the interest rate is higher.
The interest you pay on your loan is also deductible on your taxes (in most cases). If you itemize, this can help you pay less in taxes or get a larger refund.
See Also: Current 15-Year Fixed Mortgage Rates
APR: What it is and how it's calculated
APR represents how much you’ll pay for your loan, including interest plus upfront and required fees. Like the interest rate, it's expressed as an annual rate. A lender is required by the Truth in Lending Act (TILA) to disclose the APR. It’s designed to give you straightforward information about the true cost of the loan by accounting for fees and interest. For instance, a loan with a very low interest rate might look like a good deal judging by the interest rate alone. But if it has high fees, it could be more expensive than a loan with a higher interest rate but no fees.
Like amortization, calculating APR is complex. Use a mortgage APR calculator to see how points and other fees impact the loan's APR. For example, a $400,000 30-year mortgage with two points and an interest rate of 7% would have a 7.2% APR.
Mortgage APR vs. interest rate
APR and interest rate make a big difference for mortgages. This is because mortgages have many fees that, when accounted for, change how much you’ll pay.
The APR may include mortgage costs such as:
- Interest
- Discount points
- Origination fees
- Mortgage insurance
- Some closing costs
It does not include:
- Taxes
- Homeowners insurance
- HOA fees
- Home inspection
- Appraisal
- Credit report fees
- Title insurance
“The APR is important because it’s going to tell you how much this loan is going to cost you in upfront fees,” says Alexa DePaolo, branch manager for Prosperity Mortgage Group powered by Edge Home Finance Corporation. “So when you’re seeing an interest rate at 6% and an APR at 6.2%, that’s a good indication that this is not a terribly expensive loan. There’s minimal difference between those two.”
“But if I’m seeing an interest rate at 6% and my APR is 7%, that means that this is a really high-cost loan. That’s going to be a very expensive loan when it comes to fees,” she says.
Tip
When you review offers, find out what the APR includes. Some banks offer interest rate discounts for existing customers, so the published APR may reflect that. Find out if you’d need to set up an account or meet other requirements to get a lower rate.
Tips for evaluating APR and interest rates when choosing a loan
Here’s how to evaluate APR and interest rates when you compare offers from different lenders.
Compare the right numbers on your loan estimate
First, you’ll want to only look at the numbers that lenders have control over. This boils down to two questions to ask your lender:
- What is your interest rate?
- What are your lender-specific loan costs?
The other costs when you’re getting a mortgage, such as title insurance, homeowners insurance, and property taxes, aren’t determined by the lender.
DePaolo says it’s possible that if a lender knows you’re shopping around, it may exclude these fees or give a lowball estimate to make its offer look better.
“Comparing a bottom line to a bottom line is not the best way to compare if you're getting the best cost rate,” DePaolo says.
Provide property-specific information on your loan estimate
DePaolo says to make sure the lender has all the property information so it can give you an accurate estimate of the interest rate.
“Interest rates are based on not only credit scores, but they can change based on ZIP codes, loan amounts, loan-to-value ratios, and property types,” she says.
Watch your interest rate and lender credits on a no-closing-cost loan
DePaolo also advises buyers to pay attention to their interest rate and lender credits if they’re looking at no-closing-cost loans. No-closing-cost loans let you spend less upfront, typically because closing costs are rolled into the loan amount. If you purchase lender credits, the lender will usually give you money upfront to pay closing costs in exchange for a higher interest rate over the entire loan term. Both of these can reduce the amount you’ll need upfront, but it’ll cost more over the life of the loan.
Note
Closing costs typically range from 2% to 5% of the home’s price. For a $200,000 home, this would be about $4,000 to $10,000.
How APR affects credit cards and loans
Unlike mortgages, credit card APRs are usually the same as the interest rate. However, you might see different APRs that apply to different types of transactions.
For example, the regular APR on a credit card might be 25.99%, but the cash advance APR is 29.99%.
You might also see an introductory 0% APR on purchases or balance transfers. For these offers, be sure you know the terms and conditions. Most cards require balance transfers to be initiated in the first 60 to 90 days (depending on the card), and most charge a balance transfer fee. After the introductory period, the APR will return to the regular APR.
FAQ
How do I find the APR on a loan offer?
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Is APR more important than interest rate?
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Can APR change after agreeing to a loan?
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