Interest Rate VS APR: What’s the Difference?
Are you in the process of purchasing a home and find yourself confused by all the different terms? Many homebuyers can have a hard time distinguishing the difference between their interest rate and APR.
Read on to learn the true difference between these two terms.
What Your Mortgage Interest Rate Means
The interest rate on your mortgage is the cost you pay to have the loan. It’s shown as an annual cost, even though you’re paying part of it every single month.
For example, let’s say you buy a $250,000 house. You have $50,000 to put down, so that means your mortgage starts at $200,000. If you have an interest rate of 3.8%, over the course of a 30 year loan you’ll pay about $162,000 in interest.
How is the interest for your mortgage determined? A lot of factors come into play.
- What are the current federal rates?
- What is your credit score?
- Do you have a good debt-to-income ratio?
- What type of loan are you getting?
- Is this your only mortgage, or do you have another one?
At the end of the day, the more faith a lender has in your ability to repay the loan, the better your interest rate will be.
Your payments and the overall amount are based on the rate, not the APR. So what is the APR?
What is an APR on a Mortgage?
The APR you see on mortgage documents also refers to the annual cost you’re paying for the mortgage… but it’s not just the interest rate. It also accounts for other things you’re paying.
For example, your APR will also include
- Private mortgage insurance
- Closing costs
- Loan origination costs
- Points you purchased to get a better interest rate
It may seem more confusing, but the APR was actually created to help give you, the borrower, a better understanding of everything you’re paying. That way you can compare your options more easily to determine what’s best for you.
For example, let’s say you have two loan options:
- Option A has an interest rate of 3.5% and an APR of 3.7%
- Option B has an interest rate of 3.5% and an APR of 4%
If you just looked at the rate, these loans would look the exact same. But the APR of Option B shows it to be more expensive than Option A.
That’s where knowing and understanding your APR makes a difference.
When to Be Careful Using APR
One thing to keep in mind is that APR will vary from loan type to loan type. For example, the APR on a fixed-rate mortgage shouldn’t be compared to an adjustable rate mortgage. The loans are very different, so you’re not comparing apples to apples.
But an APR comparison is great when you are comparing two loans that are the same type.
Do you have any other questions about your interest rate vs. APR? Reach out to one of our Art of Homeownership Mortgage Professionals and we’ll answer any questions you may have. We’re here for you.