Understanding APR and Interest Rate, and How They Compare

When looking into different home mortgage options to purchase your dream home, it’s important to know how much these loans are going to cost you in the long run. Two of the most common terms you will see in this process are “interest rate” and “APR,” or annual percentage rates. These terms may seem interchangeable, but each provides different information about the mortgage you’re signing and the amount of money you will have to pay.

Interest Rates

When you pay back a loan, you are not only paying for the amount you borrowed; you pay back the full amount plus an annual percentage. This percentage is known as the interest rate. Interest is the fee you pay to take out a loan.

The amount of interest you will have to pay depends on two things: your credit score and prevailing rates. The higher your credit score, the lower your interest rate will typically be. Sometimes, interest rates can be fixed and stay the same year after year. Other times, interest rates are adjustable and change every year or every few years.

Annual Percentage Rates

The annual percentage rate, or APR, is a broader measure of the long-term cost of a mortgage than an interest rate can provide. These rates are usually determined by the lenders themselves.

The APR includes the interest rate you must pay plus other costs associated with taking out the loan, including:

  • Discount points and lender credits
  • Mortgage insurance
  • Broker fees
  • Closing costs
  • Loan origination fees

The APR is usually higher than the interest rate since it includes these additional costs. However, the APR may cost more over time than what is advertised, since interest rates change over time. If you have an adjustable mortgage, the APR is not effective in determining the long-term costs of the loan since interest rates under these agreements fluctuate often.

Why Are These Rates Important?

The APR and the interest rate of a mortgage are important numbers to know when shopping around for a loan. First, they help you compare costs between different types of mortgages. In addition, they help you determine if you can afford the loan in question. Interest rates help you determine what your total monthly costs will be. The APR helps you determine the long-term cost of the loan.

Now that the difference between APR and interest rate is clear, consider how these numbers play into mortgage amounts. For example, say you take out a $400,000 loan over a 30-year period. You have a fixed interest rate of 5%. Without taking APR into account, your monthly payment will be approximately $1,167 per month and your total cost will be $420,120.

However, additional fees amount to $5,000. Your monthly payment will now be around $1,182, and your total cost will be $425,250. The APR for the loan will be 3.546%.

Are you ready to purchase your first home? Connect with home financing experts at Security Home Mortgage today. We provide loan education, pre-approval, and financing options to prospective homeowners throughout the Salt Lake City and Orem areas.