If you’re applying for a mortgage, the two most important numbers affecting your home loan costs are the interest rate and APR (annual percentage rate). Understanding how the two differ will help you make better decisions on which mortgage best fits your situation.
In this blog, we’ll explain the difference between the interest rate and APR and how to evaluate both as your shop around for mortgages.
Interest rate vs. APR - what's the difference?
- The mortgage interest rate represents the percentage of the loan you have to pay yearly. This is the cost of borrowing the original loan amount.
- For example, if you had a 5% interest rate on a $300,000 mortgage, you would pay $1,250 monthly and $15,000 annually.
- Whether a fixed-rate (where the interest rate stays the same) or adjustable rate (where the interest rate changes based on factors set by the loan), these rates do not reflect any additional costs that are charged by the loan.
APR (annual percentage rate)
- The APR of a mortgage includes both the interest rate and all the additional costs you have to pay to get a loan. These include items such as broker fees, origination fees, and closing costs. This is also shown as a percentage.
- For example, let’s say you had a 5% interest rate on a $300,000 mortgage again, and the fees on the loan added up to $6,000. To get the APR, add the fees to the principal loan amount to get a total of $306,000. Then use the 5% interest rate to get a new annual total of $15,300. Now, divide $15,300 by $300,000 (the original loan amount) to get an APR percentage of 5.1%.
How to use the interest rate and APR to shop for mortgages.
The interest rate is fairly straightforward. The rate itself is a result of both current market rates, the borrower’s down payment amount, and credit score. The higher your credit score (and the larger the down payment), the lower your interest rate will be and your monthly payment. As you shop around, you’re likely to choose the one with the lowest rate.
For the APR, the rate can vary depending on the mortgage lender since each lender’s fees to process the loan are different. As you shop around, the APR is best taken into account based on how long you plan on staying in the home, because the APR fees are divided over the entire life of the mortgage.
Take a look at this following table from Bankrate as an example of how the costs and fees change and show their value over the life of a $200,000 30-year mortgage for $200,000 with different rates and APRs.
How long you stay in a home is critical.
If you plan on staying in the home for the life of the loan, you’ll want the lowest APR since it will cost you the least in the long run. If you plan on moving in a few years, choosing a higher APR (smaller upfront costs) will cost you less in the short term.
Borrowers often overlook this fact. The APR takes into account all the closing costs. The value is only at its greatest if you plan on staying in the home until you’ve paid off your mortgage.
When in doubt, ask a loan officer.
Although being informed yourself is important, don’t be afraid to ask your mortgage lender to do some of the lifting for you. When you begin your application process, make sure to share with them how long you plan on staying in the home so they can offer you the best deal for your situation.
To get started, try out our free, no strings attached mortgage calculator on our home page. You’ll be able to run numbers with live rates and compare the interest rate and APR as you scroll through different loan options.
Also, if you’re still in the early stages of buying a home, we have a free guide for first time home buyers available for download. The eBook will give you a road map of how the mortgage process works before you dive deep into the details.