APR vs interest rate: What’s the difference?

When shopping for a mortgage, it can be difficult to know how to make a true apples-to-apples comparison. Some lenders advertise interest rates that sound much better than their competitors’ — but often, that’s because they’re disclosing the basic interest rate on a loan, whereas others are listing the annual percentage rate (APR).

Although both figures relate to the cost of financing, they differ in key ways. So, what’s APR vs the interest rate? Basically, the interest rate of a loan measures how much interest will accrue on the loan balance while APR accounts for interest plus other fees that you’ll have to pay, amortized on a yearly basis.

Understanding the distinction can make you a more savvy mortgage shopper— and potentially save some money along the way.

Difference between APR and interest rate

Expressed as a percentage, both the APR and the interest rate provide benchmarks for you to compare different loans, and what the cost is to borrow money. The key difference is that the APR includes many of the other fees you’ll need to pay to get a mortgage. Interest rates are lower than APRs, which is why you’ll often see them advertised so prominently (while the APR is relegated to the teeny-weeny fine print).

For example, consider a 30-year fixed-rate mortgage for a $350,000 home where the buyer is making a 20 percent down payment. The lender advertises an interest rate of 5 percent, but the borrower has to pay a 1 percent origination fee and some other fees that add up to $800. Those extra costs make the APR 5.111 percent — and that figure is effectively the total amount of interest you’re paying.

Why is the APR higher than the interest rate?

The APR of a loan is higher than the loan’s interest rate because it considers multiple costs of borrowing. The interest rate of a loan simply describes the rate at which interest will accrue on the loan’s balance. APR takes interest into account but also adds fees that you have to pay and some other charges. Because you are adding additional costs to the interest costs, APR will always be higher than the simple interest rate.

What is an interest rate?

The interest rate attached to a mortgage is a reflection of the cost you’ll pay to borrow the money. With a fixed-rate mortgage, the rate never changes for the duration of the loan (for example, 30 years for a 30-year mortgage). The rate on an adjustable-rate mortgage (ARM) can change at certain intervals based on market conditions.

How are interest rates calculated?

Interest rates are partially determined by factors that are completely out of your control, such as inflation, the ups and downs of the broader economy and the lender you choose to work with. Because of these factors, mortgages rates are constantly changing. You might see a rate of 4.98 percent today, only to see 5.25 percent tomorrow. This is why mortgage rate locks can be a valuable tool as you shop for a home.

Lenders take a close look at your financial picture — your credit history, your debt-to-income (DTI) ratio, your plans for a down payment and other pieces of your life — to set your rate. There is a simple rule with mortgage rates: The higher your credit score, the lower your interest rate will be.

What is APR?

APR stands for annual percentage rate. It represents the cost of your mortgage by including the interest rate and some other fees and closing costs.

APR is not the same as your interest rate. For example, if you have to pay an origination fee or points, those expenses would be included in the APR.

As a result, if you’re weighing mortgage rate vs. APR to get a feel for how your mortgage will impact your budget, the APR should give you a clearer idea. It’s not always totally illuminating, though.

The Truth in Lending Act (TILA) requires that mortgage lenders disclose the APR to borrowers. It’s important to note, however, that lenders might not include all fees in the APR — they’re not required to include certain costs such as credit reporting, appraisal and home inspection fees. Ask your lender what is and isn’t included in the APR when comparing offers so you have an accurate understanding of how much each loan will cost.

How is APR calculated?

Determining the APR involves three key figures: the interest rate, fees and any points you choose to pay upfront. You can use Bankrate’s APR calculator to get a sense of how different fees and points can impact the overall cost of your loan.

To ensure you’re getting the best APR on your home purchase, collect APRs from a few different mortgage lenders. Comparing rates can help you save thousands over the life of your loan by getting the best rate.

Mortgage interest rate vs APR examples

Here are examples comparing APR vs. interest rate for a $300,000, 30-year fixed-rate mortgage:

If you’re planning to stay in your home for a shorter period and want to purchase discount points to lower your rate, you need to do the math to determine your break-even point. Bankrate’s mortgage points calculator will help. Simply put, you need to stay in the home long enough to allow enough time for the rate savings to balance out those extra upfront costs.

Final word on APR vs interest rate

In the interest rate vs APR conversation, APR can give you a better idea of the real cost of the loan in your life. So definitely look at loans’ APRs when you’re comparing multiple mortgage offers. And make sure each APR is including the same expenses.

Still, if you’re considering buying a home, you should understand and look at both percentages — to fully appreciate what is actual interest cost, and what amounts to the additional fees’ impact.