Residential houses in Michigan
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When you’re taking out a mortgage there are two numbers that reflect mortgage costs: the interest rate and the annual percentage rate, or APR. Although they both describe how much you’ll pay, they’re not the same thing.

Interest rate vs. APR

  • The interest rate is the cost of borrowing the principal loan amount. The rate can be variable or fixed, but it’s always expressed as a percentage.
  • The APR is a broader measure of the cost of a mortgage because it includes the interest rate plus other costs such as broker fees, discount points and some closing costs, expressed as a percentage.

Why two numbers?

Both the APR and the interest rate are ways for consumers to comparison shop as well as determine affordability of the loan. The interest rate is determined by prevailing rates and the borrower’s credit score. For instance, the higher your credit score the lower your interest rate will be. Your monthly payment is based on the interest rate and principal balance, not the APR.

The APR, conversely, is determined by the lender, since it’s composed of lender fees and other costs that vary from lender to lender. The Federal Truth in Lending Act requires that borrowers disclose the APR in every consumer loan agreement.

$200,000 mortgage with different rates, APRs
Interest rate 4.5% 4.25% 4%
Discount points 0 1.5 3
Points and fees $2,800 $5,800 $8,800
APR 4.619% 4.492% 4.36%
Monthly payment $1,013 $984 $955
All costs, 3 years $39,281 $41,220 $43,174
All costs, 10 years $124,404 $123,866 $123,380
All costs, 30 years $367,613 $354,197 $343,739

Think of the interest rate as a way to gauge your monthly costs whereas the APR gives you a big-picture estimate of the cost of the loan.

However, it’s important to note that lenders might not include all fees in the APR. For example, they’re not required to include certain costs such as credit reporting, appraisal and inspection fees. Be sure to ask your lender what is and what isn’t included in the APR when you comparison shop so that you have an accurate understanding of how much each loan will cost.

Time horizon matters

If you plan to stay in your home for decades, it makes sense to take out a loan that has the lowest APR because you’ll end up paying the least to finance your house. But if you don’t plan to stay in the house that long, it may make sense to pay fewer upfront fees and get a higher rate — and a higher APR — because the total cost will be less over the first few years.

“Because APR spreads the fees over the course of the entire loan, its value is optimized only if a borrower plans to stay in the home throughout the entire mortgage,” says Gloria Shulman, founder of CenTek Capital Group in Beverly Hills, California.

Figure the break-even point

If you’re planning to stay in your home for a shorter period, you need to do the math and determine your break-even point. Bankrate’s mortgage points calculator will help.

For example, if you chose a 0.25 percent lower rate for an additional 1.5 points because of the lower APR, but you moved in five years, you paid more than you had to. Your break-even on the points was seven years.

Unfortunately, those calculations are often confusing to homeowners, which is why it’s important to weigh your options carefully or get some expert advice.