Understanding the Difference Between the APR and Interest Rate


BY The Lenders Network

difference between interest rate and apr

4 minute read

When shopping for a home loan you have probably came across the term APR.

The APR is usually a bit higher than the interest rate.

But what is the difference between the APR and Interest Rate?

We’re going to take a look at each term and help you understand the difference.

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What is APR?

APR stands for the annual percentage rate on a loan. This is the amount you will pay annually, including interest, lender fees, origination fee, and other various fees. When borrowing money the lower the APR is on a loan the cheaper it will be over time, but it doesn’t mean you’ll have the lowest monthly payment.

Annual percentage rates give you a better idea of how much you’re really paying on your loan. The APR has to be disclosed to the borrower by Federal law under The Federal Truth and Lending Act. You can shop and compare lenders and loan offers based on the APR.

The APR can be higher or lower depending on if points are being added. Often times lenders will advertise low APR rates that are artificially lower because discount points are required to be paid.

APR on an adjustable-rate mortgage will not be accurate since the APR does not include the higher rate paid after the initial low rate period ends.

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Interest Rates

You annual interest rate is a basic look into just the interest you are being charged for a mortgage loan without taking other fees into account. Interest rates are lower than the APR usually by a few tenths of a percentage point.

Most people shop lenders and use the interest rate as a way to compare loan offers. By finding the lowest interest rate you will get the lowest monthly mortgage payment. If you want to know the total cost of the mortgage loan you should compare the APR rates quoted to you. The best APR may not be the best rate or lowest payment but it will be the cheapest over the life of the loan.

APR vs Interest Rate Comparison Chart

The difference Between APR and Interest Rate is simple. APR is the true cost of the loan, while the interest rate is just the amount of interest you’ll pay.

The chart below is from BankRate it shows the total costs and APR over the life of a $200,000 mortgage loan. 1.5 discount points are used and cut the rate by 0.25% and added another 1.5 points will cut the rate by 0.50%.

difference between apr and interest rate

How the APR is Calculated

Let’s say you have a fixed-rate mortgage for $100,000 with a 5% mortgage rate and $1,000 in closing costs. The monthly mortgage payment is $537.

Your other option is a 4.5% rate with closing costs of $4,000.

Which is the better deal?

This is where knowing the APR comes in handy. The first loan has an APR of 5.09%, while the second loan has a 4.85% APR. This means that the second loan will save you the most money over time.

What is More Important to You?

Having the lowest mortgage payment – If your main objective is to have the lowest monthly payment on your loan then you should be looking for the lowest interest rate. And because your payment will be lower you will be able to qualify for a more expensive house.

Paying the least amount on the life of the loan – Now you’re not really interested in having the lowest mortgage rate you just want to pay the least amount possible on your mortgage loan then you should be looking for the lowest APR.

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Getting a Lower Rate

Your credit score is the most important factor lender use to know which rate they can offer. The higher your credit score, the lower the rate and APR will be. Make sure you maximize your credit score before applying for a loan to get the best rates.

If you’re shopping for a Government insured loan like an FHA loan or VA loan then you’re in luck. Government loans typically have slightly better rates than a conventional loan will have.

Pay Down Your Credit Card Balances

The quickest and simplest way to increase your credit score in a hurry is by paying down the balances on your credit cards. The amount of available credit you have used up is called your credit utilization ratio, and it accounts for 30% of your overall score. Only your payment history (35%) has a bigger impact on your credit rating.

Try to pay down your credit card balances to less than 15% of the credit limit. This is the optimal credit utilization ratio to maintain on your credit cards to have the highest score possible.