What’s the Difference Between Interest Rate and APR?
If you’re applying for a mortgage, it’s time to get familiar with the term APR and how it’s different from an interest rate. Annual Percentage Rate, or APR, is the amount of interest on the total amount of your loan that homeowners will pay every year over the term of the loan. The APR is different from the interest rate, which is the cost you pay each day depending on your mortgage balance.
Homeowners should not let these terms intimidate you, especially if this is your first time buying a home. To help clarify, here is a breakdown of the two terms.
First, let’s talk about mortgage interest rate.
Mortgage Interest Rate
The easiest way to put it is the interest rate is the cost you will pay every day the borrowed money is owed. This rate does not reflect fees or any other charges home buyers may have to pay for the loan. It is just the interest. There is a formula your lender will use to calculate a payment schedule that includes your principal and interest on the loan.
How Interest Rate is Determined
Interest rates can fluctuate from day to day depending on changes in the housing market conditions. Even saving a fraction of a percent on your interest rate can save you thousands of dollars over the life of your mortgage.
When calculating, there are a number of factors that can affect your rate. First, your credit score is a numerical representation of your track record of paying off your debts. Everything from credit cards to college loans are on your credit report. Mortgage lenders use your credit score to predict how reliable you’ll be in paying your home loan. Typically, consumers with higher credit scores receive lower interest rates than consumers with lower credit scores.
Your loan amount and how much of a down payment you have also impact your interest rate. A 20% down payment makes a lender feel a lot more secure than a 10% down payment.
Buyers who you don’t have enough money to put down 20% will have to pay PMI, an extra monthly fee meant to reduce the risk if you default on your loan.
The location of where you are buying your home also affects mortgage interest rates. For example, the strength of your local housing market can drive up or drive down interest rates.
Lastly, your loan type and the loan term also affect your interest rate. The conventional mortgage is the most popular and is typically targeted at buyers who have good credit and a steady income. However, if you don’t have stellar credit, there may be government assistance that can help you out.
The length of your loan also comes into play. The shorter the term, the lower the interest rates—and lower overall costs—but larger monthly payments.
APR Determining Factors
Your APR measures the total cost of borrowing money, expressed as a percentage rate. It also determines the total amount you pay yearly over the life of the loan.
APR includes the interest rate offered on your mortgage, discount points, origination fees, and other costs. It’s generally higher than the interest rate. The higher your APR, the more your payments are over the length of your mortgage.
It’s always important to check both interest rate and APR when looking for a mortgage. Buyers can find the information on your good faith estimate usually on the first page.
Keep in mind that when you see lenders advertise APRs, they are talking about rates for people with the best credit scores. Depending on your situation, your rates may be higher.
Also be aware that lenders that offer low APRs often require high upfront fees. They are still building the cost into the loan, it’s just whether you pay it upfront or over the length of the loan.