Buying and Selling

APR vs. Interest Rate: Why it Pays to Know the Difference

Both numbers are important to consider, and here’s how to understand what each means

Man and woman looking at computer screen

Shopping around for a home involves more than just comparing properties against your wish list … it also means shopping around for the best rates on your mortgage. But this doesn’t mean you should shop on interest rates alone. You’ll also encounter annual percentage rates, or APR. What does each represent? How are they related? Knowing what each rate means for your budget will be key to feeling confident in your decision. Be sure to understand these five important points.

1. What each rate means.

The interest rate reflects the interest you pay annually on the principal loan amount. For example, a 4% interest rate on a $100,000 mortgage loan would mean you’ll pay $4,000 in interest per year, paid in increments each month with your mortgage payment. (NOTE: This is an illustration and not a quote for an actually available rate.) The interest rate can be fixed over the life of the loan or variable (adjustable). Adjustable Rate Mortgage (ARM) products have interest rates that may increase after consummation.

APR is interest over the entire life of the loan. It reflects the interest rate, but also includes the extra fees you pay upfront to get the loan, such as:

  • Discount points
  • Loan origination fees
  • Loan processing fees
  • Underwriting fees
  • Appraisal review

As a result, your APR:

  • Is often higher than the interest rate
  • Is not used to determine your monthly payment
  • Will be unique to each situation

2. How they affect your bottom line.

The lower your interest rate, the less money you’ll pay each month. The lower the APR, the less you’ll pay at closing and over the entire life of the loan.

If your goal is to pay the least amount of money each month, you’ll want to focus on interest rates. If you’re focused on having lower closing costs and paying the lowest overall price over the entire term of the loan, you’ll want to consider APR carefully. If you are paying more upfront fees to bring down your interest rate, you will need to factor these costs into your closing budget. Depending on certain factors, increasing your closing costs to lower your interest rate may not pay off in the long run. 

3. How you should compare rates.

It’s important to never compare an interest rate to an APR because they measure different things—always look at the same kinds of rates for an apples-to-apples comparison. You should also be careful when comparing APR on adjustable rate mortgages (ARMs). Those are based on assumptions about rates and won’t accurately reflect the maximum interest rate your loan could reach.

4. How long you’ll be in your home.

If you’re settling into your forever home, you may wish to consider a loan option with a low APR because you’ll pay less over the life of the loan. If you are only going to stay for a few years, it might make sense to pay fewer upfront fees, even if the interest rate might be higher. It can take several years for the long-term rate savings of paying more upfront fees to come into effect. A mortgage lender can help you figure out what makes the most sense for you and your financial goals.

5. How mortgage insurance factors in.

If you don’t put 20 percent down on your house, you’ll need to purchase private mortgage insurance (PMI). Don’t compare loan rates if one includes mortgage insurance and one doesn’t. Insurance is one of the costs factored into APR, so the APR will naturally be higher on a loan with mortgage insurance.

During every step of the home buying process, you’ll want to determine what matters most for you. When it comes to the rate, think about whether you’d rather save money on out-of-pocket costs at closing (as well as over the life of the loan) or keep your monthly payments lower. It can be complicated to review and compare rates, so make sure you find a trusted lender who can help you navigate the process.

Have questions?

Whether you’re just getting started or ready to take the next step, talk with an expert to help guide you through the home-buying process.

This content does not constitute legal, tax, accounting, financial or investment advice. You are encouraged to consult with competent legal, tax, accounting, financial or investment professionals based on your specific circumstances. We do not make any warranties as to accuracy or completeness of this information, do not endorse any third-party companies, products, or services described here, and take no liability for your use of this information.