APR vs Interest Rate: What's the Difference for a Mortgage?

When you're comparing mortgage loan offers, you’ll see two different terms: interest rate and annual percentage rate (APR).

While people often use the terms interchangeably, there are important differences between them. Knowing what each means and how they work will help you pick the best mortgage lender.

APR vs. interest rate: What’s the difference?

Both the mortgage interest rate and APR represent costs associated with your loan, but the latter is inclusive of the interest rate and certain fees. 

• Mortgage interest rate is the basic yearly cost of borrowing, or the percentage charged on the principal balance. Lenders use the interest rate to calculate your monthly payment.
• Mortgage APR builds on the annual interest rate. It reflects the interest rate and certain finance charges, such as points, mortgage broker fees, and mortgage insurance premiums. It does not include every closing cost.

The annual percentage rate of a mortgage typically includes the following:

• Interest
• Origination fees
• Some closing costs
• Discount points (also called mortgage points)
• Private mortgage insurance premiums/charges (PMI)
• Mortgage broker fees

Because APR includes the interest rate and additional costs, it’s typically higher than the interest rate. If there’s a large gap between the two, the loan comes with high fees, while a small gap signifies relatively few (or low) fees.

The table below shows key differences between a mortgage interest rate and APR at a glance:

Interest rate: Definition and calculation

Your mortgage interest rate is the percentage of the loan balance that your lender charges you each year to borrow money. Lenders use this rate to calculate your monthly principal and interest payment.

Mortgage interest rates come in two forms: Fixed and adjustable.

• Fixed interest rates stay the same for the life of the loan. If you take out a 30-year mortgage with a 6% fixed rate, the interest rate across all 360 payments will be 6%.
• Adjustable interest rates have a fixed rate for an initial period (such as 3, 5, 7, or 10 years), after which time the rate can move up or down based on a market index. Rates typically adjust every 6 or 12 months.

Lenders determine your interest rate based on several factors, including your credit score, income, loan amount, current debt, and down payment size. Current market conditions, which are out of your control, also have a large impact on the rate you’re offered.

To calculate your monthly payment, lenders use a standard mortgage amortization formula. This spreads out interest and principal payments over the life of the loan to keep your monthly payment consistent. However, the amount of your payment allocated to interest decreases over time as your principal balance falls, while the amount you pay toward the principal increases.

The interest calculation for a mortgage payment isn’t simple math. We recommend using a mortgage calculator (or viewing the amortization table provided by your lender) to understand how interest costs change over the life of your loan.

APR: Definition & calculation

The annual percentage rate (APR) on your mortgage reflects the total annual cost of the loan, including certain fees. Like the interest rate, APR is expressed as a percentage of the loan amount. APR includes:

• Interest rate
• Origination fees
• Certain closing costs
• Discount points (also called mortgage points)
• Private mortgage insurance (PMI)
• Mortgage broker fees

The APR paints a clearer picture of how much you’re actually spending to borrow.

For covered mortgage transactions, Regulation Z of the Truth in Lending Act (TILA) requires lenders to disclose the APR and sets guidelines for how lenders must calculate it. The APR disclosure is in the loan estimate’s comparisons section as “Your costs over the loan term expressed as a rate. This is not your interest rate.”

For instance, assume:

• Loan A has a 5.90% interest rate.
• Loan B has a 6.00% interest rate.

Loan A seems like the better choice. However, if Loan A’s APR is 6.50% while Loan B’s APR is 6.30%, Loan B may be the cheaper option in the long run.

In most cases, the loan with the lowest APR is the best choice. However, if you plan to move or refinance within a few years, it may be worth taking the loan with a higher APR if it has lower upfront fees (this could be the case if the interest rate is higher, for example). This is because you may not keep the loan long enough to recoup the upfront costs through interest-rate savings.

Calculating the APR for a mortgage is even more complicated than calculating interest. Review the loan estimate for any mortgage you’re considering. By law, the loan’s APR will always appear on page three.

What costs does APR not include?

A mortgage APR includes some upfront fees, but not all. Many excluded fees would be required with or without a loan when purchasing a home. Exceptions include:

• Appraisal fees
• Title insurance
• Attorney fees
• Home inspection costs
• Credit report fees
• Notary fees
• Escrow fees
• Transfer taxes
• Property taxes and homeowners' insurance premiums (paid into escrow)

You’ll typically pay these closing costs and fees out of pocket at closing, so make sure you have the funds available. 

What should you look at when shopping for a mortgage?

While APR offers a clearer picture of the total cost of the mortgage, comparing both the APR and the interest rate is helpful.

• Use the interest rate to estimate monthly mortgage payments: If your goal is to keep monthly payments as low as possible, focus on the interest rate.
• Use the APR to compare loans across lenders: Because every lender must calculate APR using the same methodology, it’s the best tool for comparing loan offers. The APR exposes a lender advertising a low interest rate but charging high upfront fees.

As you compare offers, remember to consider how long you plan to keep the loan. A loan with a higher interest rate but fewer upfront fees will have a higher APR, but if you plan to sell or refinance quickly, it often makes sense to choose this loan rather than one with a lower APR but substantial upfront costs. 

How do APR and interest rate affect your monthly payment and total loan cost?

Your interest rate and APR both reflect borrowing costs, but they impact your loan in different ways.

• Interest rate: The interest rate directly determines your monthly payment. Lenders use it to calculate how much interest accrues each month. A higher interest rate yields a higher monthly payment, while a lower interest rate results in a lower monthly payment.
• APR: APR reflects your overall loan costs, not your monthly payment. Because APR includes upfront fees like origination fees, PMI, and discount points, it shows how much you’re really paying over time to borrow money.

The short version:

• Interest rate impacts your monthly payment.
• APR impacts your total loan cost.

Tips to get a lower APR on your mortgage

Since mortgage loans are large and have long repayment terms, every tenth of a percent in your APR makes a difference. Here are some tips to get a lower APR on your mortgage:

Shop around

Compare multiple loan offers to determine which lender offers the lowest monthly payment, upfront fees, and total loan costs. Otherwise, you could end up with a loan that costs more than it should. 

“I always say to check out multiple options for a lender [because] every lender has access to different loan products,” advises Diane Romelli, a Realtor in Cincinnati, Ohio. 

While Romelli believes in prioritizing the lowest APR, she also says good real estate agents can help you find the right lender for “not so straightforward situations,” like bank statement loans for self-employed buyers or USDA loans for rural homes. “A good realtor is going to have many different options that are going to serve their clients in the best way possible.”

Improve your credit score

If you don’t need to move ASAP and your credit score isn't considered “good” or better (a 670 FICO score or higher), spend time working on it before you buy. Borrowers with strong credit scores qualify for the lowest mortgage rates.

You can’t usually improve your credit score overnight, but you can improve it over time. Here’s how:

• Make on-time payments: Payment history is the single most important factor FICO uses in calculating your credit score, so pay all your bills on schedule.
• Pay down your debt: Credit utilization is the second most important factor in your credit score. Keep your balances below 30% of the credit available to you. 
• Avoid opening or closing accounts: Getting new credit typically requires a hard credit inquiry, which temporarily lowers your score. Closing a credit account can lower your score by decreasing your average age of credit.
• Dispute errors on your credit report: Review your credit reports from the three major credit bureaus. If you notice any errors, work with the bureaus to get them removed.

You can also improve other financial credentials as well. 

“[Pay] close attention to your debt-to-income ratio,” says R.J. Weiss, certified financial planner and founder of The Ways to Wealth. “While having a high debt-to-income ratio could still make you eligible for a mortgage, staying at reasonable levels is going to allow you to look at more options when it comes to shopping for a mortgage.”

Ideally, your debt-to-income ratio will be below 36%, though some lenders accept higher ratios. You can lower yours by increasing your income — like through earning a raise or a consistent side hustle — or by paying down debts.

Make a larger down payment

You might be able to qualify for a lower mortgage rate by making a larger down payment. Just make sure you leave enough money in your bank account to cover closing costs and emergency expenses, and to meet the lender’s cash reserve requirements.

Weiss recommends hitting the 20% mark, if possible.

“Similar to having a lower debt-to-income ratio, having a 20% down payment is going to put you in the best class of borrowers for a bank and give you more options to look at,” he says.

Choose a different type of mortgage

Choosing a shorter loan term, such as a 15-year mortgage instead of a 30-year mortgage, typically results in a lower rate. 

Similarly, you may qualify for a lower rate if you get an adjustable-rate mortgage (ARM), as ARMs often offer lower starting rates. However, you take the risk of a sharp increase in borrowing costs if rates go up over time.

If you qualify, you may also be eligible for lower rates with an FHA loan, VA loan, or USDA loan.

Buy discount points

Most lenders allow you to buy down your rate with discount points (also called mortgage points). 

Typically, a single discount point costs 1% of the total loan amount and decreases your rate by 0.25%. So, paying a one-time fee equal to 4% of your loan amount could reduce your rate by an entire 1%.

If you have a 6.5% rate on a $300,000 loan, the table below shows you what you could spend to lower your rate:

Buying points is a good strategy if you plan to stay in the house—with the same mortgage—for the long term. It’s also a good strategy if you need a big tax deduction the year you’re buying. (This is because you can generally claim a tax deduction for mortgage points for the year you paid them.)

“If your goal is to refinance in a year or two, after, say, improving your credit score or if you’re hoping rates drop, you likely won’t come out ahead,” explains Weiss. “If, on the other hand, you’re going to stick with the home and mortgage long-term, [buying mortgage points] starts to make more sense.”