APR vs. Interest Rate: What to Use When Choosing a Mortgage
If you've been looking for a mortgage, you may have seen the terms "APR" and "interest rate" pop up. But do you really understand the difference? And which should you use when deciding which mortgage to go with?
Stick with us as we guide you through what each term means as well as how you should use them in your mortgage search.
Interest Rate vs. APR
Interest rate and APR do have some overlap, but they're not exactly the same.
Interest rate is a measurement of the cost of borrowing from a lender. It's a percentage of the principal loan amount and is either fixed (as with a fixed-rate mortgage) or adjustable (as with an adjustable-rate mortgage, or ARM).
Annual percentage rate (APR) is a measurement of the overall yearly cost of the loan, expressed as a percentage. It reflects not only interest, but also other fees, points, and charges included with the loan.
Why Are There Two Measurements?
Interest Rate Reflects Monthly Payment
The interest rate is helpful for understanding the monthly payment you'll be making. When comparing the interest rates of two loans, you are basically comparing short-term payments rather than the overall cost of the loan.
Interest rates are influenced by a few different factors, including:
- The national market
- Borrower qualifications
- Loan type
- Down payment amount
- Length of your loan (30-year, 15-year, etc.)
- Your choice of lender
The interest rate is located on the first page of the Loan Estimate (a document you should receive from any lenders you've applied with) under "Loan Terms."
APR Reflects the Overall Price of the Loan
While the interest rate is just one part of the loan (albeit an important one), the loan's APR gives you a fuller understanding of the cost over the entire life of the loan.
Lenders must disclose the APR since it is a requirement of the Federal Truth in Lending Act. This disclosure gives borrowers the big picture, helping them make a more informed decision.
APR includes costs such as:
- Interest rate
- Loan points
- Private mortgage insurance (PMI)
- Closing costs
- Other costs
The APR is calculated differently by each lender. It is located on the third page of the Loan Estimate, under "Comparisons."
How to Use Interest Rate & APR in Your Mortgage Search
One thing you should never do when comparing numbers between loans is compare the interest rate of one loan to the APR of another. They measure different things, so comparing them won't help you. Instead, compare interest rates to interest rates and APRs to APRs.
Since the APR gives a fuller picture of the loan, you might be wondering why you would even use the interest rate at all. The whole cost is all you need to know, right?
The APR may be more useful in some situations, and it might not matter as much in others. In fact, neither interest rate nor APR is more important in determining which mortgage you should choose, since they simply highlight different aspects of the loan and their individual importance will depend on your specific circumstances. Take a look at our example below to see why.
Example of APR vs. Interest Rate in Mortgage Shopping
Say you're going to buy a home, but you don't see it as a long-term home. You think you'll probably end up moving in five or so years. In looking for a home loan, you narrow your mortgage options down to two 30-year loans:
- Loan A has a lower interest rate and higher APR
- Loan B has a slightly higher interest rate and lower APR
You think that since Loan B has the lowest APR, it should be the better choice . . . right? The entire cost of the loan is cheaper, after all.
But that isn't always the case.
Yes, the overall costs might be lower for Loan B, but it still may actually cost more in the first few years than Loan A, depending on points, fees, and other costs.
Maybe you'd only start seeing the benefits of Loan B after 10 years, while Loan A is the cheaper option up until year 10. If you were planning on staying in your home for 20 years, you'd want to go with Loan B, but since you're planning on moving in 5 years, Loan A is definitely the loan for you.
So when making comparisons, you'll want to take a step back and look at more parts of the loan. Consider the actual costs for how long you think you'll have the loan and determine which offer will be more cost-effective for you.
Of course, you can't always say for certain how long you'll have the loan, but an estimate can help save you thousands of dollars.
APR & Interest Rate Calculator
There are different calculators that are helpful for comparing varying loan aspects. They allow you to plug in the numbers to see an estimate of what your payments would be.
One useful calculator is Bankrate's Mortgage Points Calculator. On this site, you can calculate your payment and view a report of your payment schedule over the life of the loan. Comparing these numbers between loans will help give you a more detailed picture of what the numbers actually mean.
But, even if you do make calculations yourself, you'll want to check with the lender for the final numbers. There may be costs that you haven't included or other details that you need in order to make a decision.
Who We Are
Don't get lost in the numbers when our team of mortgage professionals does this kind of thing every day. At Elevate Mortgage, we care about each of our clients and strive to make sure that you fully understand your options.
Give us a call at (888) 935-3828 to see how we can walk you through the process and help you find the right loan for your exact situation.