Interest rate and annual percentage rate (APR)-those are the same thing, right? Unfortunately, too many mortgage buyers don’t realize the answer is no. The interest rate on your mortgage loan is different from the APR and understanding both is important to getting the best deal on your mortgage.
The interest rate on a loan is the cost for borrowing the mortgage principal. It is a percentage of the amount and can be either fixed or variable. The interest rate is amortized over the life of the loan and the interest payment is rolled into the monthly mortgage payment.
The annual percentage rate is a measurement of total costs to the borrower. The APR includes not only the interest rate but also the upfront costs like points, broker fees, closing costs, etc. All of these fees are factored in and expressed as a percentage.
Why It Matters
The interest rate and the APR provide the borrower with ways to compare other loans and to figure out which loan is the best value. By looking at the interest rate, borrowers can see how much their monthly payments will be. When choosing between several mortgage offers, they can compare both the interest rate and the APR to understand the true cost of each one. For example, one loan may have a lower interest rate but more discount points may be required. The APR on that loan may actually be higher than one with a higher interest rate. Comparing loans based on APR can help borrowers understand what they will pay once all fees and points are accounted for. (It is important for borrowers not to compare the interest rate from one loan with the APR from the other. Otherwise it will not be a fair apples-to-apples comparison.)
APR and interest rate are also important tools for deciding which loan is best based on a borrower’s housing time frame. The longer a borrower plans to stay in his house, the more it makes sense to choose the mortgage with the lowest APR. That’s because the APR is calculated by spreading the fees over the life of the loan. If a borrower moves before the loan term is up, the APR could actually be much higher. If borrowers only plan to be in their home for a few years, they may find it more cost effective to take a higher interest rate with fewer upfront fees. It wouldn’t make sense to pay several points to bring down the interest rate only to move within a few years. The initial cost would be more than the monthly interest savings; in some cases a higher APR may be more desirable.
Both interest rates and APRs are useful for comparing mortgage costs but they are different. Call Minnesota Residential Mortgage, Inc. today at 651-797-4090 , we can help you to figure out which interest rate and APR make the most sense for you.