Buying a home is one of the most exciting things you can do. But it can also be an overwhelming process—particularly if you are a first-time homebuyer borrowing money.
Although there are many options to consider and terms to understand, few are as important as interest rate and APR. Understanding these terms is critical to determining which mortgage lender is best to work with when purchasing your home.
So, what exactly is the difference between mortgage interest rate and APR (annual percentage rate)?
The quick and easy answer: Interest rate is the percentage the lender charges for lending the money. APR is the all-inclusive cost of borrowing the money. It reflects the mortgage interest rate PLUS other charges (points, fees, closing costs, private mortgage insurance, and more). Therefore, the interest rate will almost always be lower than the APR.
Now for a deeper dive into the difference between a mortgage interest rate and an APR.
Mortgage Interest Rate
A mortgage payment includes the principal and the interest on the loan. The principal is the money you borrowed from your lender. The interest is a percentage-based fee that you pay the lender for borrowing that money.
For example: If you take out a $250,000 fixed-rate mortgage with 4% interest, then you will pay $10,000 in total interest—or $833.33 per month—during the first year.
Mortgage interest rates can be either fixed or adjustable. A fixed-rate mortgage means exactly how it sounds—the rate is fixed and never changes. With a fixed-rate mortgage, your monthly principal and interest payments are predictable throughout the lifespan of the loan.
An adjustable-rate mortgage (ARM) can increase or decrease throughout the time you pay off the loan. Whenever your ARM adjusts, your monthly mortgage payment will also change. While ARMs typically have a lower initial interest rate than fixed mortgages, there is less certainty for the borrower as the rate might change. Most ARMs have a rate that is fixed for a certain number of years and then can adjust—and they normally include an interest rate cap limiting how much and how often they can change.
When a mortgage lender offers you a rate, that lender is taking the following information into consideration:
- The type of loan you are borrowing
- The city in which you are purchasing the home
- Down payment amount
- The length of the loan
- The price of the house
- Your credit history
Annual Percentage Rate (APR)
As mentioned above, your APR includes the mortgage interest rate as well as other fees the lender charges you to borrow the money. Therefore, APR is a broader measure of the total cost of borrowing money and gives you more information about what you are really paying.
APR is also a tool that lets you compare mortgage offers. Each offer will have a different combination of interest rates, discount points, charges and fees. Comparing APRs is important because it gives you a fair, apples-to-apples comparison of the total cost.
For example: Going back to our 4% interest rate on a $250,000 loan — Let’s say that when you include closing costs, application fees, and settlement costs, you add another $7,000. The APR on this total amount ends up being 4.23%.
Unlike interest rates, APR is set by individual lenders who choose how much to charge for additional fees on top of the interest rate. Some lenders might charge more for closing fees than others. As a result, two lenders offering the same mortgage interest rate could offer different APRs.
Our Mortgage Team is Here to Help You
Choosing the right mortgage and mortgage lender for you is critical to buying a home. It will save you money and help you feel comfortable with your monthly payments.
If you are ready to take the exciting leap into home ownership, contact our mortgage team today. Because every homebuyer’s journey is unique, we will work to understand your specific needs and find a loan option that sets you on the best path to homeownership.