The terms APR and interest rate are often used interchangeably by people to talk about the cost of buying a home, but they aren’t the same. Understanding the differences can help you compare offers and pick the best mortgage for you.

APR vs. Interest Rate - What’s the difference?

You might think the terms “interest rate” and “APR” refer to the same number, but they are actually two distinct things and can vary widely. It is important to understand the differences between the interest rate and the APR when evaluating mortgage options so you can choose the best for yourself. First, let’s get a refresher on the basics.

What is an interest rate?

The interest rate is the cost of borrowing money. It is the fee a lender charges a borrower to finance a loan. Interest rates are typically expressed as a percentage, for example 4.5% or 6.78%.

Interest rates can be fixed, meaning it does not change over the life of the loan, or variable. Fixed-rate mortgages are more common than adjustable-rate mortgages (ARMs) whose rates fluctuate over time.

What is APR?

Annual Percentage Rate (APR) is the loan’s interest rate PLUS any additional fees or expenses charged by the lender. It is also described as a percentage, but it is not the same as the interest rate. When comparing the two, APR is a more accurate picture of the cost to borrow money from a lender.

What’s included in the APR?

There are several types of expenses included in the APR. It’s important you understand these fees when comparing loans.

In 1968, the federal government passed the Truth in Lending Act which mandates lenders provide standardized information about the costs of borrowing money, including a loan’s APR and interest rate. This information will be part of your Loan Estimate documentation and your closing disclosure, which contains a loan’s full terms.

Let’s take a look at the expenses included in APR:

• Loan interest rate: This is the rate a lender is charging you to borrow money. You can price shop and compare this from lender to lender.
• Origination fees: Lenders charge a fee for processing, or opening, a loan. It covers the time they spend to underwrite and fund the loan. It is typically expressed as a percentage and often falls between 0.5% and 1% of the total loan amount. This rate is negotiable, as well.
• Discount points: Also called mortgage points, these are upfront payments of prepaid interest that reduce future monthly payments. Mortgage points will decrease your interest rate, but are still included in the APR calculation.
• Mortgage insurance: A fee paid by borrowers when a down payment on a loan is less than 20%. Private mortgage insurance (PMI) can be cancelled once a borrower has sufficient equity in a home.
• Mortgage broker fees: When working with a mortgage broker, their fee will be included in the APR calculation.
• Closing costs: Other fees associated with finalizing a loan are included in APR, including document preparation fees and certain escrow and settlement charges.

Why is APR higher than the interest rate?

The APR includes additional fees, outlined above, that are not included in the interest rate calculation.

How is my interest rate calculated?

Lenders evaluate a number of factors when developing an offer to extend credit. Borrowers with higher credit scores typically receive lower rates, but that’s not always true. Lenders are not required to offer you the lowest rate possible and you should compare the rates offered by different lenders.

Here are the factors that most impact interest rates on a loan:

• Credit score & history: Lenders use this to determine the likelihood a loan will be paid back. They include details about loans, credit cards, payments and other financial information. Be sure to check your credit report periodically as they can contain errors that impact your score.
• Location: Depending on which state, or even the county you live in, lenders may offer you different rates.
• Loan amount: The dollar amount of the loan, and selling price of the property itself, can impact the interest rate you are offered. Both smaller than average loans and larger loans could attract higher interest rates.
• Loan term: This is the length of time you have to pay back a loan. As a general rule, shorter-term loans will attract lower rates.
• Down payment: When you borrow money from a lender, a larger down payment can help to lower your interest rate. These borrowers are viewed as being less risky than one that puts down a smaller amount towards equity.
• Fixed or adjustable-rates: Adjustable-rate loans are often lower, at least initially, than fixed-rate mortgages, but those rates and their corresponding payments can balloon later on.
• Loan type: There are a variety of mortgage types in the U.S. Interest rates will vary widely between conventional, FHA, VA, USDA and other loan types.

Is the APR negotiable?

Certain fees included in the APR are negotiable, including the interest rate, origination fee, and broker’s fee. Fees like mortgage insurance and certain closing costs are not negotiable. Price shopping a mortgage with a variety of lenders is always a good idea.

How do I evaluate mortgage offers with APR?

Using APR should give you an apples to apples comparison when shopping for a mortgage. It will include all fees and factor in different interest rates being offered by each lender. Evaluating a mortgage based solely on its interest rate is a mistake because it does not account for all the fees and expenses a lender may be adding to your loan.

How do I get a lower mortgage APR?

A lower mortgage APR can save you tens of thousands of dollars over the life of a loan. There are a number of ways you can lower the mortgage APR:

• Shop the interest rate: Interest rates are negotiable and you can shop around the interest rate you are offered. If you secure a lower rate, just be sure the APR is also decreasing as well. You don’t want to get a lower interest rate just to pay more in fees and expenses.
• Improve your credit score: Borrowers with better credit scores often get access to lower rates and more favorable loan terms.
• Increase your down payment: Larger down payments can decrease APR in two ways. 1) You may get access to a lower interest rate by putting more money down and 2) down payments of greater than 20% will help you avoid fees like mortgage insurance, which is included in APR.

Can mortgage APR change over time?

Yes. Borrowers who opt for an adjustable-rate mortgage instead of a fixed-rate loan, meaning the interest rate changes over time, can expect big movements in the corresponding APR. You may also stop paying a fee, like private mortgage insurance, that could also lower the APR.

How can I get the best mortgage rate overall?

In the end, the best mortgage for you is going to depend heavily on - you! Personal financial circumstances vary widely among borrowers and what’s best for one homebuyer might not be for the next. A few things to keep in mind when selecting a loan:

• Compare: Get multiple mortgage offers and check out the interest rate, fees, and APR.
• Calculate: Online tools can help you estimate total loan costs.
• Negotiate: Don’t be afraid to tell lenders you found a better deal elsewhere.
• Monitor: Keep an eye on the market as mortgage rates do fluctuate.
• Consult: Maintain an open dialogue with brokers and others as your search continues.

In conclusion, it’s important to evaluate mortgage offers clearly and consistently when buying a home. To do this properly, you have to understand the difference between APR and a mortgage interest rate. Only when these financial metrics are understood can you grasp the true cost of a mortgage and make a more informed choice.

The information provided here is for informational purposes. When interest rates and loan program information are included, it is for illustration purposes only and not a solicitation or quote for services. This is not an advertisement or loan estimate. Current interest rates, loan programs and qualification criteria can change at any time. If you have questions or need assistance, we can be reached using the contact information above.