APR vs Interest Rate: How Are They Different?
If you’ve been exploring mortgage options, you’ve likely come across both APR and interest rate—two terms that seem similar but carry different implications for your home loan.
In this APR vs interest rate guide, we’ll show you exactly how they differ, how they influence your monthly payments, and which one to focus on when choosing a loan.
By the end of this guide, you should have a good understanding on how to use the information provided to get the most suitable mortgage deal for you.
Ready to see competitive rates and APRs tailored specifically to you? Get started with Rate’s digital mortgage application to explore personalized loan options in just a few clicks.
What Is an Interest Rate?
Interest rate is the cost you pay to borrow money. It is expressed as a percentage of the principal loan amount. This percentage indicates how much you’ll be charged annually for the loan.
Mortgage interest rates can be fixed-rate or variable. A fixed-rate mortgage keeps your interest rate steady throughout the loan term, providing consistent monthly payments, while a variable rate fluctuates with market conditions, which can lead to changing monthly payments over time.
At the start of the loan term, most of your monthly payments go toward interest, with only a small portion reducing the principal balance.
Over time, as the loan amortizes, the balance shifts, and more of each payment goes toward paying down the principal loan amount.
What Is Annual Percentage Rate (APR)?
An APR, or Annual Percentage Rate, represents the total cost of borrowing for a mortgage, expressed as a percentage which includes fees such as origination fees, closing costs, broker fees, discount points, and mortgage points.
These extra costs give a more comprehensive view of the total cost of a loan.
Mortgage APR varies from lender to lender, and some lenders offer lower APR than others because they likely have fewer upfront fees or better overall terms.
Is APR Monthly or Yearly?
APR, or Annual Percentage Rate, is always expressed as a yearly rate, reflecting the total cost of borrowing over a 12-month period.
Even if some fees are paid upfront or monthly, the APR calculation consolidates these costs into an annualized number to provide a consistent basis for comparing different loan offers.
This means it takes into account not just the interest rate but also any origination fees, broker fees, and other costs that may be charged throughout the year.
By expressing it annually, APR offers a standardized way for consumers to see the true cost of a loan, helping you better evaluate and choose the most cost-effective option.
APR vs. Interest Rate: Key Differences on Mortgage Loans
Although both APR and interest rates provide valuable information, they differ significantly in what they represent.
Components
Unlike the loan interest rate, which only reflects the cost of borrowing money, APR includes additional fees such as origination fees, closing costs, broker fees, discount points, and mortgage points.
Under the federal Truth in Lending Act (TILA), mortgage lenders are required to disclose these extra costs in your loan estimate, so you can compare apples to apples when considering different loan offers.
Impact on Total Loan Cost
APR gives a fuller picture of total borrowing costs over the period of time you hold the loan, while the interest rate only affects monthly payments.
A higher APR means a higher total cost for the loan, impacting your bottom line in the long run, whether it's a mortgage, auto loan, or another form of financing.
How Does APR Differ from a Nominal Interest Rate?
The nominal interest rate is the rate stated on the loan without accounting for any additional costs or fees.
In contrast, the loan’s APR provides a more accurate representation of the true cost of borrowing by including all charges associated with the loan, such as mortgage insurance and closing costs.
Why is the APR Higher Than the Interest Rate?
The APR is typically higher than the interest rate because it factors in more than just the interest you pay on the principal balance.
Other expenses like broker fees, origination fees, and closing costs are not included in the loan’s interest rate but are reflected in the APR.
These additional costs increase the overall borrowing expenses, making the APR exceed the nominal interest rate. Understanding this is crucial for homebuyers or those navigating lines of credit looking for other funding options.
How to Use APR and Interest Rate When Comparing and Shopping for Loans
When comparing loans, focus on the loan’s APR if you want a clearer picture of the total cost, including fees and upfront costs. This is especially useful for long-term loans like mortgages or auto loans.
For a loan you plan to keep long-term, a lower APR is often more beneficial. However, if you're looking at short-term options, such as an adjustable-rate mortgage or a loan you plan to refinance within a few years, consider focusing on the interest rate instead.
A lower interest rate can help reduce monthly payments and make it easier to manage your finances over a shorter period of time.
How Are APR and Interest Rates Calculated?
APR and interest rates are calculated using different methods:
Interest Rate Calculation: This is based on the principal loan amount and does not include any fees.
APR Calculation: The APR incorporates fees and other costs, making it a more comprehensive measure of the loan’s true cost.
Example Calculations
Interest Rate Calculation
For a $200,000 loan at 4% interest over 30 years:
- Annual Interest: $200,000 × 0.04 = $8,000
- Monthly Interest: $8,000 / 12 = $666.67
APR Calculation
For a $200,000 loan at 4% interest, with $5,000 in additional fees:
- Total Interest: 4% × 30 years × $200,000 = $240,000
- Total Loan Cost: $240,000 + $5,000 = $245,000
- APR: 4.083% (adjusted for fees)
To make it easier to calculate your monthly mortgage payments based on interest rates and APR, you can use our Mortgage Calculator to see exactly how these factors impact your loan costs over time.
How Do You Convert APR to Interest Rate?
To convert APR to interest rate, remove all additional fees and only consider the core interest rate component. This requires recalculating based on the principal balance.
Does 0% APR Mean No Interest?
0% APR doesn’t always mean no interest. Hidden fees like processing or administrative costs can still add up.
Once the promotional period ends (typically 12 to 15 months), a higher interest rate often applies, leading to increased borrowing costs if the balance isn’t paid off.
Before committing to a low APR offer, it’s crucial to check the credit report provided by the Consumer Financial Protection Bureau for any details about these terms.
Carefully calculate whether you can realistically pay off the loan during the 0% period to avoid costly surprises down the road.
What Is Considered a Good APR for a Loan?
A “good” APR can vary significantly depending on your credit score, the type of loan, and current market conditions. Typically, borrowers with excellent credit scores can secure lower APRs, while those with lower scores may see higher rates.
For mortgages, a good APR might range between 3-4%, but this can fluctuate based on economic trends and lender policies.
For credit cards or personal loans, a good APR is usually higher, often starting around 10% or more, due to the increased risk for lenders when there’s no collateral involved.
It’s always wise to shop around and compare rates to find the most competitive APR available for your financial situation.
How to Get a Lower Interest Rate and APR
Getting a lower APR or interest rate can significantly reduce your loan costs. In this section, we’ll provide practical tips for securing better terms.
Improve Your Credit Score
Raising your credit score can help you qualify for lower interest rates and APRs. Focus on timely payments, reducing debt, and maintaining a healthy credit report.
Consider Different Loan Types
Certain loan types, like government-backed loans, tend to offer lower APRs. Consider shorter-term loans or home equity lines of credit for better rates.
Negotiate with Lenders
You can also negotiate with lenders for lower rates. Ask if they can waive or reduce certain fees, or offer a discount on points.
APR vs. Interest Rate: Which Matters More?
Choosing between APR and interest rate depends on your goals.
Use APR when comparing the total loan cost over time and interest rate when focusing on monthly payments or short-term strategies. Also, if you’re looking at refinancing or selling soon, the interest rate might be a more important factor.
What Factors Affect the APR I Receive on a Loan?
Factors such as credit score, loan term, and down payment can affect the APR you receive. Lenders consider your overall financial profile to determine the risk of lending to you.
How Can I Start the Mortgage Process Today?
Now that you’ve learned the key differences between APR and interest rate, it's time to move forward in your mortgage journey, and we’re here to support you every step of the way.
At Rate, we simplify the mortgage process by offering a user-friendly digital application that makes getting pre-approved easier than ever and provides instant clarity on your home affordability options with just a few clicks.
By getting pre-approved with us, you’ll have access to real-time credit score assessments, personalized loan options, and up-to-date mortgage rates tailored to your financial situation.
Ready to see loan options that fit your needs? Start your journey with Rate’s digital mortgage application today to find the right loan for you!