Mortgage Rate vs Annual Percentage Rate (APR): What is the Difference?

Taking out a mortgage loan is one of the most important things a person can do in their lives. It’s unlikely you’ll ever take out a loan worth more money, even if you purchase multiple cars or go to an expensive school for college.

Because of this, many people like to take special care when comparing different mortgage loans against one another. It’s easy enough to compare the interest rates between two mortgage loans. But you might also want to consider the loans’ APRs or annual percentage rates.

Not sure what exactly the difference is between APR vs. mortgage rate? Fortunately, we’ve broken down the details for you below. Let’s get started.

What’s a Mortgage Interest Rate

When you take out a mortgage loan, the loan comes with a mortgage interest rate. The interest rate is, in a nutshell, how much it costs to borrow the principal (or initial total) loan amount, not counting the cost of added interest over time.

Interest rates can be variable or fixed, meaning they vary based on market factors, credit scores, and other elements, or they remain the same throughout the loan’s duration. Mortgage interest rates are expressed as a percentage of the principal amount.

When you get your mortgage bill every month, you are not only required to pay the minimum loan amount for that billing cycle. A certain proportion of the remaining balance will be added to the total loan amount – this is the interest rate. Because of this, most people try to pay their mortgages by including both the minimum payment amount plus a certain amount of interest.

Over time, interest can dramatically increase the amount of money a borrower pays over the course of a mortgage loan in total. Interest rates are necessary because they are the primary way that lenders, such as banks or other financial institutions make money by lending money to borrowers

What’s an APR

An APR is the annual cost of taking out a loan from a borrower. However, unlike the interest rate, the APR includes various fees, such as closing costs, mortgage insurance costs, broker fees, and more. All of these costs are added together, and your APR is expressed as a new percentage.

Because an APR includes more factors than just the principal loan amount, APR rates are typically higher than interest rates when compared side-by-side. One keynote is that your monthly payment is not based on APR, but rather based on the interest rate on your promissory note.  A lower APR could mean lower monthly mortgage payments. With a lower rate, it results in paying less interest over the life of the loan.

What’s the Difference? 

The only difference between a typical mortgage interest rate and the APR is what’s included in both percentages. An APR includes the mortgage interest rate you pay for the loan from the mortgage lender as well as some of the upfront fees the lender charges you to get the loan. One thing to keep in mind is that the greater your credit score is, the lower your interest rate will inevitably be.

The mortgage interest rate only tells you the cost of borrowing money for the principal loan amount. Say that you take out a mortgage for $300,000 over 30 years. Your interest rate of 3% or so only applies to interest for the initial $300,000 and whatever is left of the principal as you pay it down with each billing cycle. 

To simplify, the APR expresses the cost of borrowing the $300,000 principal loan in addition to the other costs and lender fees associated with buying a house. Closing costs like broker fees, appraisals, title insurance, third-party fees, underwriting fees, inspection fees, notary fees and more. 

Purchasing a $300,000 house with a mortgage loan could cost you closer to $330,000 or a similar amount. Your APR could be 4% when including these extra costs. 

When you are shopping around for a mortgage loan, it’s important to review the APR and the interest rate and use both values to compare different loans against each other. Lenders are required by federal law to tell you the APR for a given loan to ensure that borrowers have all the information necessary to make a wise decision.

Which Should You Compare: APR or Mortgage Rate

Both. However, the APR will be a more accurate estimate for what you will pay throughout a loan’s lifespan than the mortgage rate by itself. Because of this, most people like to compare APRs when considering two different loans from separate lenders.

Here’s an example:

  • Say that you can compare loan offers for a $200,000 house with a 30-year term limit. The first loan has an interest rate of 4.25%, including a 1% origination fee and $1000 in various other fees. All told, your total extra expenses add up to $3000
  • You can alternatively opt for a different loan of $200,000 with an interest rate of 4%. It also includes a 1% origination fee and $1000 and other fees but also has an optional discount point worth $2000 you can purchase if you choose. The total costs for this loan are $5000 compared to $3000

As you can see from the example, the first loan has a higher interest rate of 4.25% and lower overall fees. The second loan has a lower interest rate of 4% but higher fees. You “buy” the discount point by paying $2000 to knock down the interest rate by 0.25%. This means that, over time, you’ll pay less money on the mortgage using the second loan compared to the first loan.

The second loan, when checked, will have a lower APR since you’ll pay less in total over the 30-year loan lifespan when you include the principal loan amount, the fees, and the interest rate. 

So in this hypothetical example, the second would be a better choice.

What if You’re Investing in Real Estate?

If you’re buying a house to start investing in real estate, APR is still a better metric to focus on. Real estate investing is a long-term game, so you must determine the real price you’ll pay over a mortgage’s loan term rather than the less-than-complete interest rate.

House flippers, in particular, should consider APR carefully when taking out a mortgage loan (if applicable – some flippers buy homes outright to avoid having to take out a loan at all).

What if You Plan to Switch Loans?

We say almost everybody because not everyone plans to keep a mortgage loan for a full 30-year term. In the above example, the first loan will cost less for the first five years and eight months, even with its higher interest rate. That’s because you don’t pay another $3000 in extra fees or purchase the optional discount point.

The second loan costs more for that initial period but eventually costs less if you keep the loan for more than five years and nine months.

Therefore, sometimes loans with higher APRs but lower interest rates can be better if you only plan to keep the loan for a certain amount of time before refinancing or selling the home and taking out a new mortgage loan entirely.

It’s ultimately up to individuals to decide how to weigh APR vs. interest rate when comparing different loans and considering their overall budget and financing goals.

Other Things to Keep in Mind When Comparing Mortgage Loans

Comparing mortgage loans for the best results can be tricky, so keep these things in mind to ensure that you get the best deal for your unique situation.

  • Always be careful when comparing the APRs of two or more adjustable-rate mortgage loans. If the mortgage loan has an adjustable rate, the APR may not necessarily accurately reflect the maximum interest rate for the loan over its lifespan. As the name suggests, the rate could be adjusted in the future to a higher than the projected percentage
  • Similarly, be careful when comparing APRs for a fixed-rate loan against an adjustable-rate loan for the same reasons 
  • Some homebuyers decide to take out home equity lines of credit, which also include APRs. Be careful when comparing the APR of a typical mortgage closed-end loan with a home equity line of credit
  • When in doubt, use a loan estimator or calculator to determine the total lifetime cost of a loan. Many of these calculators can cut through the complex math involved in calculating the total cost of a loan when factoring in the APR, interest rate, and ancillary fees

Summary

All in all, APR and mortgage rate are both important values to consider when deciding whether to take out a mortgage loan. However, between the two, the APR will likely give you a more accurate estimate for how valuable or affordable a loan is in the long term compared to just the mortgage rate.

Have more questions about what makes a good mortgage loan or how to determine a good APR from a subpar rate? Check out Seek Capital’s guides and breakdowns, or contact us today about personal loans and other financing options.

 

Sources:

Annual Percentage Rate (APR) Definition | Investopedia

Current Mortgage Rates | Mortgage Rates Today | US Bank

What is a Home Equity Line of Credit and How Does it Work? | Bank of America

Experian APR Calculator | Experian

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