After you apply for a mortgage, you’ll see something called APR (or annual percentage rate) listed on your loan estimate. This number measures the costs you can expect to pay for the loan expressed as a yearly percentage rate. Because it reflects total costs — and not just interest paid — APR is a good way to compare mortgage offers from different lenders.
What is the difference between APR and interest rate?
Since APR and interest rates are both expressed as percentages, it can be easy to confuse the two — particularly if you’re a first-time homebuyer. They aren’t the same, though.
Here’s a quick look at how the two numbers differ from each other:
- Interest rate: Also commonly called the “mortgage rate,” this is how much interest you’ll pay to borrow the money, as a percentage of the total loan amount.
- APR: This reflects the annualized cost of taking out your loan and includes interest, fees, points, mortgage insurance, and more.
A loan’s APR is typically higher than its interest rate since the APR includes the interest paid plus other fees and charges. Both numbers are useful, though.
Generally, if your goal is to have the absolute lowest monthly payment, comparing loan options by interest rate is your best bet. If you know you’ll be in the home for a while and want to save more in total long-term costs, though, your APR is the best way to gauge your savings.
What is APR and what is included?
The annual percentage rate, or APR, provides a broader measure of the cost of borrowing money. The APR includes the interest rate along with other charges you might pay for the loan.
Because it includes costs beyond the interest rate, your APR is usually higher. In addition to the interest rate, the following costs may be baked into your APR:
- Interest
- Lender fees
- Mortgage broker fees
- Discount points
- Closing costs
- Mortgage insurance
For example: With a 30-year home loan for $160,000, you’re paying $4,754 toward interest in year one. But say your lender also charges you $2,800 upfront in origination fees and discount points. That means your mortgage costs are actually $7,554.
By spreading the fees over the course of your loan term, the APR takes that upfront cost and helps you better measure it against other mortgage offers.
How your APR is determined
The annual percentage rate is determined by your financial institution since it’s composed of costs that vary from lender to lender.
According to the Truth in Lending Act (TILA), your lender must disclose the APR in all of your mortgage documents. But they might not include every fee in the APR.
To understand what you’re paying for, ask your lender to explain how it calculates your rate.
How does APR affect your mortgage?
Your APR can give you insight into how much you’ll pay for your mortgage in total over the course of your loan’s term. If you have a 30-year loan, for example, it reflects the annualized total cost of the loan, as if you were paying all costs over the full 30 years.
APR is influenced by many factors, like your:
- Credit score
- Debt-to-income ratio
- Down payment
- Lender
Use our monthly mortgage payment calculator below to see how your interest rate affects your monthly payment.
Generally, the higher your credit score, the lower you can expect your interest rate to be (and thus, the lower your APR will be, too). Higher credit scores indicate a lower-risk borrower, which allows a lender to offer more favorable terms, including lower interest rates and APRs. Lower credit scores will often result in the opposite.
Find Out: How to Buy a House
How to compare loan offers by mortgage APR
APRs vary from lender to lender and loan to loan. For this reason, you must compare several options before deciding which mortgage to move forward with.
Let’s look at how two loan offers with different APRs might measure up. The below scenarios are both for $250,000 home loans with 30-year terms and assume you will make fully amortizing payments for the full 30-year term of the loan.
On the loan with the higher APR (Loan 2), you’ll pay only slightly more per month, but in the long run, you’ll pay more than $26,000 in additional interest to pay the loan off over 30 years. This is why it’s critical to factor in APR when comparing your mortgage offers — especially if you know you’ll be in the home for the long haul.
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Low mortgage rate vs. low APR: What’s more important?
When it comes to deciding between mortgage loans, it’s a good idea to check both the interest rate and the APR. The interest rate tells you how much interest you’ll pay every year, while the APR indicates the interest rate plus extra costs added by the lender.
Because the APR gives you a broader picture of the costs you pay, it’s the more important figure when calculating your loan costs.
Don’t be afraid to ask your lender questions
When you apply for a home purchase mortgage (or a mortgage refinance), the lender will give you what’s called a loan estimate. This will detail the APR, interest rate, closing costs, and other fees you’ll pay in the transaction.
Make sure you ask your lender about anything you’re unsure about — including the APR. You must have a good handle on all the different fees and costs to buy a house you can expect, so you can properly compare options and choose the best deal for your budget.
