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APR vs. Interest Rate: Key Differences

Annual Percentage Rate (APR) Helps Explain a Mortgage’s Total Cost

When you’re buying or refinancing a home, it’s important to compare the mortgage’s annual percentage rate (APR) with its interest rate.

APR and interest rate may seem similar, but they aren’t interchangeable, which is why it’s important to understand how they inform you what your mortgage will cost you. Let’s decode what they mean so you can feel confident choosing the best mortgage for your situation.

Quick Comparison: Interest Rate vs. APR

Before we dive into detailed explanations of APR and interest rates, here’s a high-level breakdown of what they mean:

	Interest rate	APR
What it means	A percentage that represents the cost of borrowing money and is usually lower than the APR	A percentage that helps you understand the actual overall cost of a mortgage loan
What it includes	Only the interest to borrow the mortgage’s principal balance	Interest rate and other fees like closing costs, points, and origination fees
When it’s used	To calculate your monthly mortgage payment	To understand the actual cost of borrowing and to compare different loan offers

How Do Interest Rates Impact a Mortgage?

An interest rate is the amount you pay your mortgage lender for borrowing money from them to finance your home loan. This money is added to the loan’s principal, or the loan amount.

Interest rates change all the time, and if you have a higher interest rate, that means you’ll pay more over the life of your loan.

How Does APR Impact a Mortgage?

The APR provided by a mortgage lender expresses the total cost of a mortgage. It includes the interest charged on the principal balance (the interest rate), as well as costs and fees the lender may charge you to get the mortgage. The APR gives you an understanding of the total cost of a loan and can help you choose the right mortgage and lender.

APR is calculated similarly by all mortgage lenders, which makes it a useful tool for comparing home loan costs. APRs are expressed as percentages and can include:

Interest charges: This is the cost you’re charged to borrow money, based on the loan’s interest rate.
Discount points: Some mortgages require you to pay points (prepaid interest) to get a specific interest rate. One point is equal to 1% of the loan amount. If your loan has mortgage discount points, these costs are included in the APR. You can also choose to pay points for some loans.
Lender fees: These are sometimes called origination fees and might be charged by lenders to process your loan application. These can be a percentage of the loan amount, and are included in the APR.
Mortgage insurance: If a loan requires you to pay for mortgage insurance, the cost is included in its annual percentage rate.
Other closing costs: Typically, closing costs include loan-related fees, such as settlement/closing fees, courier fees, and wire fees (paid at closing), which are considered prepaid finance charges and are included in the APR.

Example: Mortgage Interest Rate vs. APR

Let’s look at two sample mortgage offers to compare APR vs. interest rate and see how APR helps you better understand the cost of a home loan. For this example, we’ve assumed that:

You’re buying a house with a conventional, 30-year, fixed-rate mortgage.
You’re borrowing $200,000.
You don’t have to pay for private mortgage insurance because you made a 20% down payment.

	Interest rate	Points	Lender fees	Closing costs included in the prepaid finance charge	APR
Mortgage A	3.10%	2	1%	$1,500	3.4%
Mortgage B	3.25%	0	1%	$1,000	3.37%

In this example, Mortgage A looks less expensive than Mortgage B, because it has a lower interest rate. However, Mortgage A also comes with two points and higher closing costs. When you take these points and closing costs into consideration and calculate an APR, Mortgage B is the least expensive option.

APR vs. Interest Rate Mortgage FAQs

Understanding the fine print of your mortgage can help you make a more informed decision, so here are some answers to questions you might have.

Can You Lower Your APR or Interest Rate?

It’s possible to lower your mortgage interest rate and APR, though you may find it more difficult to change your APR (primarily because many ways that lower interest rates will raise APRs). However, you can improve your credit score and save more for a down payment to potentially receive lower interest rates.

One of the most common ways to lower an APR is to make a 20% or more down payment and avoid PMI.

Why is APR Higher Than the Interest Rate?

APR is almost always higher than the interest rate because it includes the interest rate and additional fees, such as closing costs. The mortgage interest rate doesn’t take fees into account.

Should You Use APR or Interest Rate?

You should consider APR when comparing mortgages or trying to understand the overall cost of a loan. You should consider the interest rate when you’re trying to get the lowest possible monthly payment or if you’re looking at a shorter loan term, because you plan to refinance soon, perhaps.

Final Thoughts: APR, Interest Rate, and Your Mortgage

APR and interest rates work hand in hand to help you determine the true cost of your mortgage. The interest rate shows what percent of the principal you’re being charged to borrow the money, while the APR gives you a more inclusive understanding of the total cost to borrow, including the interest rate plus fees and other costs.

Understanding both can help you make your next move with the confidence that you’re choosing the right loan for your budget and plans. If you’re ready to explore loan options and see your personalized interest rate and APR that will save you the most money, get prequalified today.