Interest Rate and Annual percentage rate or APR. Are they lost siblings? Brothers from another mother? Seemingly identical, but non-identical twins? Second cousins once removed? The truth is, they’re related. They both exist in terms of the cost of borrowing money, but they represent different costs. Once you hear the breakdown, you’ll get it. Let’s review what makes an interest rate and what makes and annual percentage rate (and all their awkward family history).
If you’re interested in purchasing or refinancing a home, you probably already know that you want the lowest interest rate that you can find. But there’s another number out there — the annual percentage rate, or APR — and it’s just as critical to making the decision about how much house you can afford.
Interest rate and APR are not the same thing, but you should be comparing them side-by-side.
To do so, let’s get textbook and talk about what each one is.
The annual percentage rate, or APR, accounts for the costs of producing a loan — not just the loan amount itself. It’s a broader, more holistic view of the annual cost of the money that you’re borrowing. The additional costs included in your APR are dynamic, because they’re set by the lender and include:
- Mortgage insurance
- Broker fees
- Origination fees
- Discount points
- Closing costs
- And underwriting fees
An APR is the yearly cost of borrowing money, and because it also includes the interest rate, your APR will often be higher than the interest rate itself. Line items like closing costs can vary by lender, so give the APR that you’re offered attention, as you could be offered the same interest rate by several different lenders, but they may all offer different APRs, meaning potentially more costs in fees. And here’s the caveat: The Truth in Lending Act requires lenders to disclose a borrower’s APR, however, some costs like the pulling of your credit report, appraisal fee and inspection fee are not required to be reported in the APR. When you’re comparing offers, you’ll want to ask your lender what’s specifically included to get the most accurate representation of what each loan could cost you. A good rule of thumb to know is that the closer the APR is to the advertised interest rate, the lower the lender’s fees will be.
So, what is an interest rate?
An interest rate is simpler than the APR; an interest rate is a percentage that’s based only on the amount of money that you borrow for your home loan … there are no fees or closing costs involved. It’s just the amount that you will pay to a lender to borrow money from them. It can be fixed, or variable — as is the case with an adjustable-rate mortgage, which can change at certain times depending on market conditions.
Interest rates change frequently, daily even, as they are affected by many economic factors, like inflation, economic growth, and housing conditions. That’s why many borrowers choose to lock in a fixed rate, so they’re protected from market fluctuations. The interest rate that will be offered to you is based on your:
- Down payment amount
- Financial situation
- Credit score
- The loan amount you’re requesting
- And your debt-to-income ratio
Some other factors that are out of your control that can affect the interest rate offered to you include the Federal lending rate and market trends, or in other words timing.
How is an interest rate paid off? Part of your monthly payment will go toward the interest charged, and part will go toward your loan principal. You should receive an amortization schedule with any home loan that will break this down for you month-over-month, year-over-year, so you see exactly where your money is going.
The Bottom Line
When taking out a mortgage loan, you’ll see two interest rates as you shop around at different lenders. Those are the interest rate and APR. The interest rate is the percent of interest you pay on your loan; the APR is your interest rate and any fees that are owed to your lender.
You have more control over the interest rate you’re offered by upping your credit score and choosing a fixed-rate loan. You have less control over the APR that you’re offered, because these costs are set by your lender. To find the lowest APR available to you, compare similar loan products among several lenders.
If you’ve already applied for a mortgage, you should receive a Loan Estimate within three days. On the Loan Estimate, you can find the interest rate on page 1 under Loan Terms, and the APR on page 3 under Comparisons. These will also be listed on your Closing Disclosure, which you’ll receive three days before closing on a home. Remember to consider both when you’re choosing the best mortgage loan option for you.
This is not an offer for a loan or any type of extension. Eligibility for a loan or extension of credit from Homespire Mortgage Corporation is subject to completion of a loan application, credit, income, and employment qualification, and meeting established underwriting criteria. Rates are subject to change without notice based on market conditions. See Loan Consultant for information on program income limits, buyer contribution, area median income, debt requirements, and other application details.