When you're applying for a mortgage, you want to find the lender that will give you the best deal. 🕵️ But how do you know what that is? Check out our article that breaks down the difference between APR and interest rates to help you make the most informed decision!
To get to a proper comparison, you have to compare apples to apples and oranges to oranges, as the adage goes. So, to help you in that endeavor, we’re setting out to tackle the difference between APR and interest rate.
What is an Interest Rate?
The interest rate on your loan is the annual cost you’re paying to borrow money from your lender, shown as a percentage. It’s important to note that the interest rate doesn’t reflect any other fees, charges, or costs associated with your loan.
What is APR?
APR stands for annual percentage rate. This rate includes your interest rate, along with other costs that are part of your loan, including points, broker fees, and other charges.
APR is meant to paint a more complete picture of the total cost of your loan. Since APR includes your interest rate and any other fees that are part of your loan, it will be higher than the interest rate, unless your lender is offering a rebate on part of your interest expense.
How to Compare Mortgage Offers
Understanding that APR includes both the interest rate and fees associated with your loan, it might seem simple enough to use it as your comparison tool to select your mortgage.
But there’s another piece of the puzzle we have to consider: APR is a calculation of the total cost of the loan over the entire loan term. What that means is that the lender takes the total loan cost and divides it over the entire period, and that’s how they arrive at the APR. Since some borrowers may not keep the same loan for the entire term, it could turn out to be cheaper to take a loan with a higher APR if they’re only keeping it for a short period of time before refinancing.
The best tools to help you evaluate and compare loan offers are the required loan estimates you will receive after completing your application.
Using Loan Estimates to Make Your Decision
Loan estimates actually account for the possibility that you won’t keep the same loan for the full term. They have a five-year cost shown on page 3, calculating how much you’ll pay for the loan in the first five years in principal, interest, mortgage insurance, and other loan fees.
Another reason it’s preferred to use loan estimates when comparing your options is that they’re required to be presented to you in a standardized format. So no matter which lender you get one from, they will be in a familiar format that allows for easy comparison.
Additional Considerations When Comparing APRs
At this point, you’re well equipped to begin applications with lenders in search of the right mortgage program for your next purchase. We’ve discussed the differences between interest rate and APR and how to best compare your loan options. Here are some additional aspects to be aware of when comparing the APRs of various loan offers you receive:
- Attractive APR quotes seen in ads assume the best borrower scenario. If you see a great rate, understand that it’s typically calculated using a stellar credit score and payment history.
- Lower APRs can come with higher upfront costs. Like we discussed, APR is calculated over the entire loan term, so if you pay your loan off early or refinance it, you might end up paying more than if you’d gone with a different lender.
- Advertised APRs may not include PMI (private mortgage insurance). Lenders have some flexibility in calculating and advertising APRs, so looking at the actual quote on your loan estimate is your most accurate resource.