What is the Difference Between Interest Rate and APR?
What is the difference between Interest rate and APR?” the couple asked. “I know our realtor explained it, and so did our lender at closing, but we really don’t understand it?”
Simply, there is the advertised rate (the interest rate) to borrow money to buy a house and the real rate (the APR). There are many costs associated with taking out a mortgage. These include:
- The interest rate
- Points
- Fees
- Other charges
What is the Difference Between Interest Rate and APR?
Interest rate
The interest rate is the cost of borrowing the principal loan amount. It can be variable or fixed, but it’s always expressed as a percentage. For example, if you borrow $200,000 at 4%, you will pay $8,000 in the first year.
Annual percentage rate (APR)
The APR is a broader measure of the cost of your mortgage because it reflects the interest rate as well as other costs such as broker fees, discount points, and some closing costs. The APR is also expressed as a percentage.
Under the Truth in Lending Act, lenders are required to disclose the APR to borrowers.
“The main difference is that the interest rate calculates what your actual monthly payment will be,” says Sean O. McGeehan, a loan officer in Homer Glen, Illinois. “The APR calculates the total cost of the loan. A consumer can use one or both to make apples-to-apples comparisons when shopping for loans.” The APR will always be equal to or higher than the interest rate.
An Example of Three Lenders in Kansas City
- Aim Loan
| Loan purpose | Purchase |
| Loan product | 30 year fixed |
| Interest rate | 3.125% at 2.340 point |
| APR | 3.332% |
| Estimated total payment | $1,371/mo $8,592 fees |
- First Internet Bank
| Loan product | 30 year fixed |
| Interest rate | 3.250% at 1.564 point |
| APR | 3.374% APR |
| Estimated total payment | $1,415/mo $3,184 fees |
- Rocket Mortgage
| Loan product | 30 year fixed |
| Interest rate | 3.990% at 2.000 point |
| APR | 4.187% APR |
| Estimated total payment | $1,526/mo $7,650 fees |
The three charts are of three lenders in Kansas City on the same day. Not only can we compare the interest rates on various loan types, but we can compare APR.
Here’s the tricky part.
The APR is based on staying with that loan for the entire term of the loan. Gloria Shulman, founder of Centek Capital Group in Beverly Hills, California, writes, “The key when looking at APR, as it is for many loan decisions, is time horizon. It’s the most important question borrowers need to ask themselves before looking for a home and the mortgage that best fits their current and projected financial and family situations.”
Tip from CFPB
Take care when comparing the APRs of adjustable-rate loans. For adjustable-rate loans, the APR does not reflect the maximum interest rate of the loan. Be careful when comparing the APRs of fixed-rate loans with adjustable-rate mortgages, or among different adjustable-rate loans. Don’t look at the APR alone in determining what loan makes the most sense for your circumstances.Does it Pay to Shop for the Best Deal?
Yes! The difference between $1061 per month and $1095 per month is $12,240 in 30 years. However, it is doubtful that you will stay in the house for 30 years or go without some change in your mortgage, which will alter all the calculations.
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