The Difference Between APR and Interest Rates

When you’re shopping for a home loan, you should know the difference between APR and interest rates to assess if you are really getting the best deal. Scott Auen, senior vice president, retail lending, answers some common questions to you make the most informed decision.

What Is the Difference between APR and Mortgage Interest Rates?

The interest rate on a mortgage loan is what it will cost you to borrow the money; it’s the percentage charged by the lender on the amount you borrow. The APR, or annual percentage rate, is the interest rate plus the finance charges and fees that are incurred over the life of the loan. The APR usually, but not always, ends up being higher than the interest rate. It gives you a better idea of the total cost of your mortgage, assuming you keep it for the entire term.

How Do Banks Calculate the APR for a Mortgage Loan?

The APR for a mortgage loan is the interest rate plus the finance charges and fees over the life of the loan. However, all lending institutions don’t include the same fees in their APR calculation. By law, every APR must include mortgage insurance, broker fee, interest, points and loan origination fee. Third-party fees that legally can’t be included are notary, home appraisal and attorney costs. And there are other fees that some lenders include, and others don’t. That’s why you should ask specifically what is included so you can make an accurate assessment when comparing offers.

And How Is the Interest Rate Determined?

Overall mortgage rates are determined by external market forces such as the state of the economy, inflation rates, job growth and other economic indicators. Then, individual lenders set their interest rates based on factors such as the level of risk they are willing to incur, how competitive they want to be in the market and other considerations. Finally, internal factors—such as your credit score, the amount of the loan you are seeking and the loan-to-value ratio for your purchase—also play a major role in determining the interest rate the lender will offer you.

Which Should I Pay More Attention to?

This is not a simple answer. Basically, the interest rate will let you know your monthly mortgage payment, while the APR will give you a bigger picture of what the total cost is over the life of the loan. Which is more relevant to you depends on a number of factors.

For example, if you are buying a small home with plans to move within five (or even 10) years as your family grows, it makes more sense to pay attention to interest rates to keep your monthly payments lower. The same is true if you are likely to refinance. There are a lot of factors to consider, including the type of mortgage, however, so it’s best to talk to a mortgage loan officer who can guide you through your options.

How Can I Find the Best Mortgage for Me?

In general, take a look at both the interest rate and APR from lenders to make sure they aren’t compensating for a low-interest rate with higher fees. There are online calculators you can use that will help you calculate costs based on several factors, but for your best assessment before deciding, consult with a professional.

It’s important to compare apples with apples. The type of mortgage you are looking to get—such as fixed-rate or adjustable-rate—is also a key factor. Comparing the interest and APR rates against two different types of loans will not give you an accurate assessment.

We can help you find the best mortgage that works for you. Our loan officers are highly trained and ready to answer any questions you may have. Contact us today for more information.