Mortgage APR vs. Interest Rate

You hear a lot of numbers when you apply for a mortgage – enough to make your head spin. Two of the important numbers are the interest rate and annual percentage rate. Many people assume that they are one in the same, but they are almost always different numbers. Achroma is here to help you understand the difference so you get the best mortgage for you.

Our mortgage finder helps you figure out the best options for your needs. Notice that both APR and interest rate are listed.

What is the Interest Rate?

The interest rate is the fee for borrowing the money from the bank. This number directly affects your monthly payment. The higher the interest rate, the higher your payment becomes. This is the number most borrowers focus on.

You’ll hear the interest rate as a percentage, but don’t focus on the number alone. The type of interest rate is important too. You can get a fixed rate or an adjustable rate. A fixed rate stays fixed for the life of the loan. An adjustable rate (as the name suggests) changes over time, typically once a year, but there are variations available.

What is the Annual Percentage Rate?

The Annual Percentage Rate (APR), is more complicated. It takes the interest rate from above and adds the closing costs to it by spreading the costs out over the life of the loan. The APR is shown as a percentage just like the interest rate, so it can be confusing. 

The annual percentage rate is usually higher than the interest rate because it includes certain lender fees, such as points. The APR is the cost over the life of the loan, but as a percentage. Lenders must disclose both the interest rate and the APR when providing you with a quote.

Which Figure Should you Use?

It’s easy to focus on the interest rate when shopping for a loan. You want the lowest possible monthly payment – that’s fair. But, if a low interest rate costs you excessive closing costs, you may pay more than you realize over the life of the loan.

At Achroma, we help you decipher between the interest rate and APR to ensure that you choose the most affordable option for your situation.

For example, if you have two quotes – one for a 5% interest rate with no points and another for a 4.5% rate and paying one point, you may opt for the 4.5% rate. It makes sense, but without knowing the APR, you may end up paying more over the life of the loan for the 4.5% rate.

Use caution when comparing the annual percentage rate, though. Lenders can choose which costs they include in the APR. If you compare two offers to one another that each includes different costs in the APR, you won’t get an accurate comparison.

The Loan Coaches at Achroma are here to help you make sense of these confusing terms.

Use Caution When Looking at the APR

While the APR is a great way to compare loans and choose the least costly option, it does have its downfalls.

  • Adjustable rate loans – A loan’s APR isn’t calculated using the highest rate an adjustable rate can become. 
  • Fixed rate loans vs adjustable rate loans – Only compare apples-to-apples when looking at APRs. Don’t compare an ARM loan to a fixed rate, for example.
  • Fixed rate loans vs adjustable rate loans – Only compare apples-to-apples when looking at APRs. Don’t compare an ARM loan to a fixed rate, for example.

Focus on Interest Rates if You Want the Lowest Monthly Payment

This isn’t to say that the APR is the only number to focus on when shopping for a mortgage. The interest rate directly affects your monthly payment. If your goal is to secure the lowest monthly payment possible, you may not care as much about the annual percentage rate. 

If you plan to live in the home long-term, you may want the lowest mortgage payment. You want to minimize the amount of interest that you pay over the life of the loan. Let’s face it, interest can add up quite a bit over 30 years. Focusing on the points and APR, in this case, may not be the best option.

Focus on the Annual Percentage Rate if The Purchase is Temporary

If you don’t see yourself living in the home for the next 30 years, you may care more about what the loan costs you than the interest itself. If you will only have the mortgage for a few years, you may be willing to pay more interest on a monthly basis (temporarily) than to pay fees to lower the interest rate.

The APR takes into account many of the lender fees. If you won’t keep the loan for long, it doesn’t benefit you to pay the fees to get the ‘ideal mortgage.’ Instead, focus on the loan with the lowest APR, knowing that you’ll either sell the home or refinance the mortgage if you decide to stay.

Look at the Big Picture

The bottom line is that you should consider all factors when taking out a mortgage. You deserve fair, unbiased, and transparent lending terms that provide you with the loan that you deserve. Lenders base your interest rate and closing costs on your qualifying factors. The higher your credit score, the less debt you have, and the higher your down payment, the better terms a lender can give you. In other words, the more positive factors you can show a lender, the better your chances of getting the perfect balance between the right interest rate and APR.