APR vs. Interest Rate: What's the Difference? - SmartAsset

A mortgage interest rate is the cost of borrowing money. It’s given as a percentage. A mortgage annual percentage rate (APR) is the interest rate plus other costs associated with a mortgage, including discount points and lender fees. This is why an APR is typically higher than the simple interest rate. It is important to have a clear understanding of the difference between APRs and interest rates to assess mortgage offers from different lenders.

The simple interest rate is typically what draws you to a particular mortgage lender. It’s the number that banks commonly promote. The APR, though, will tell you the total annualized costs, including the interest rate and all other fees. So when it comes to shopping around for the best mortgage, the APR is a more comprehensive gauge.

What Is an APR?

The APR represents the true cost of a loan. It provides the complete picture of how much you’ll pay for a particular loan. With a home loan, these costs usually include the interest rate, mortgage broker fees and closing costs. APRs are expressed as a percentage, so you can compare them to each other (as long as they are the same term length and interest rate type). Generally speaking, the lower the number, the less you are paying for the loan.

The federal Truth in Lending Act mandates that all consumer loan agreements list the APR as well as nominal interest rate. This is important because it allows for easy comparison of different lenders’ offers, whether the fees are upfront or spread throughout the life of the loan.

What Is an Interest Rate?

An interest rate is the basic amount you are paying for the loan per year. After you apply for a home loan, the lender will tell you how much your payment will be monthly. However, this amount may not remain the same throughout your loan term if you get an adjustable-rate mortgage. With that kind of loan, the amount of interest and principal you pay monthly can change after a set period of time.

What’s the Difference Between APR and Interest Rate?

Both the APR and the interest rate reflect the cost of a loan, but one is narrower in scope than the other. The interest rate only indicates the basic cost of borrowing money. In contrast, the APR tells you the cost of borrowing and the additional fees that come with a loan. In the context of a mortgage, the APR is the annualized percentage of all the borrowing costs for your home loan.

How to Calculate APR?

Your lender will typically tell you the APR for your loan once you’ve applied and been approved. If you want to know it before you do all the paperwork or have a set home you want to purchase, it’s not really possible to calculate on your own, as you won’t know all the lender’s fees.

But how do lenders calculate your loan’s APR? It’s an involved process that takes into account many factors, including your credit score and history, the type of loan for which you are applying and how much debt you currently carry. Generally, lenders offer better APRs to borrowers whose financial profiles are lower risk.

Bottom Line

While you should consider both interest rates and APRs when shopping for a mortgage, the APR will tell you the true or total costs of a loan. For that reason, you will likely start by comparing interest rates, but ultimately should choose your lender based on APRs.

Tips on Getting the Best Mortgage Rate

Finding financing to buy a home can be stressful. It’s probably your biggest purchase, after all. So don’t be afraid to ask questions. If you can’t decide between a fixed-rate or adjustable-rate mortgage, for example, ask your mortgage broker to go over the pros and cons with you. Also, you could ask what they would do in your circumstances.
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