Definition
Mortgage interest rate is essentially the cost a borrower pays annually to borrow money expressed as a percentage, excluding any additional fees or charges. On the other hand, Mortgage APR (Annual Percentage Rate) is a broader measure that includes both the interest rate and any additional charges or fees (for example, mortgage insurance, most closing costs, points and loan origination fees) that are required as part of the loan package, also expressed as a percentage. Therefore, while the interest rate reflects the base cost of the loan, the APR gives a more comprehensive picture of the total cost of borrowing.
Key Takeaways
- The Interest Rate only accounts for the amount a borrower would pay yearly on the principal amount, not considering any added fees or costs. It’s often lower than the APR and is the base cost of your mortgage loan.
- The Mortgage Annual Percentage Rate (APR) incorporates the interest rate plus other charges or fees (like the broker’s fees, closing costs, etc). It provides a more comprehensive picture of how much the mortgage will truly cost annually.
- Comparing both rates can play a significant role in understanding the total cost of the loan and in choosing the best mortgage deal. While a low-interest rate might look appealing, a low APR usually signals a better deal.
Importance
Understanding the difference between Mortgage Annual Percentage Rate (APR) and interest rate is crucial in the world of finance as it directly affects the total amount one pays for a loan.
The interest rate is simply the cost of borrowing the principal loan amount usually expressed as a percentage, it determines the monthly payments for the principal that the borrower needs to make.
On the other hand, the APR is a broader measure and includes not only the interest rate but also other additional costs associated with securing the loan such as broker fees, discount points, closing costs, and other charges.
It offers a more comprehensive overview of the true cost of the loan.
Therefore, looking at both the mortgage APR and interest rate is essential to make an informed comparison between loan options and choose the most cost-effective solution.
Explanation
The purpose of Mortgage APR (Annual Percentage Rate) is to provide a comprehensive measure of the cost of a mortgage. It takes into account not only the interest rate that the lender provides, but also other costs associated with the loan, like processing fees, origination fees, and certain closing costs. This is used to give borrowers a more complete perspective of the total cost of the loan.
The APR is always expressed as a percentage, and it’s generally higher than the interest rate because it includes additional fees and costs. In contrast, the interest rate on a mortgage simply represents the cost of borrowing the principal loan amount. It does not take into account other costs associated with the mortgage.
The interest rate is used to calculate your monthly mortgage payment, which goes towards paying off the principal and the accrued interest. The mortgage interest rate is determined by market conditions and your creditworthiness among other factors. To sum it up, Mortgage APR and Interest Rate serve as critical tools to help borrowers understand and compare the true cost of their mortgage loans.
Examples of Mortgage APR vs Interest Rate
Example 1:Let’s say you’re considering two mortgage lenders. Lender A offers you a5% interest rate and Lender B shows you a6% interest rate. Based on the interest rates alone, you might think that Lender A is offering a better deal. But when you investigate further, Lender A has a5% APR while Lender B’s APR is
9%. This means that Lender A likely has higher fees and costs associated with the loan, even though they have a lower base interest rate, which makes Lender B’s mortgage actually more affordable overall.Example 2:Consider Jack. Jack wants to buy a house worth $200,000 with a fixed-rate mortgage. Two lenders offer him a mortgage; Lender X offers a 4% interest rate but with a 5% APR, and Lender Y offers a 5% interest rate with a2% APR. Despite the higher interest rate, Lender Y is offering a cheaper loan because the APR indicates that there are lower fees involved with the loan.Example 3:Sarah decides to refinance her house. Her current mortgage has a0% interest rate and a2% APR. She’s offered two refinance options: Lender C offers a
9% interest rate with a5% APR, and Lender D offers a1% interest rate with a2% APR. Lender C’s interest rate is lower, but the APR is higher, indicating higher fees. Despite the slightly higher interest rate, Lender D’s loan is more cost-effective due to its lower APR.
FAQs about Mortgage APR vs Interest Rate
What is Mortgage APR?
Mortgage APR, or Annual Percentage Rate, represents the total cost of the loan, factoring in not only the base interest rate but also any associated fees and costs. It is expressed as a percentage of the total loan amount.
What is Mortgage Interest Rate?
The Mortgage Interest Rate is the cost of borrowing the original loan amount. It is a percentage of that loan amount and does not include the costs and fees associated with the loan as the APR does.
Which is higher, APR or Interest Rate?
In most instances, the APR is higher than the interest rate. This is because it includes other fees and costs of the loan. However, it really does depend on the specifics of your loan.
What does APR mean in terms of monthly payments?
APR doesn’t directly affect your monthly mortgage payment, but it gives a more complete picture of how expensive the loan is. The interest rate determines the monthly payment. However, the APR provides a more comprehensive overview of the cost of borrowing.
Should I look at APR or interest rate when comparing loans?
You should look at both. The interest rate will tell you how much your monthly payment will be, while the APR will give you a broader picture of how much your loan will cost over time. Both are crucial components in making an informed decision about any loan.
Related Entrepreneurship Terms
- Principal Amount: The amount of money you borrow for your home.
- Amortization: The process of paying off the debt over a fixed period in regular installments.
- APR (Annual Percentage Rate): It includes the interest rate plus other costs such as broker fees, discount points etc., expressed as a percentage.
- Interest Rate: This is the cost you will pay each year to borrow the money, expressed as a percentage rate. It does not reflect fees or any other charges you may have to pay for the loan.
- Points: These are fees paid to the lender or broker for the mortgage loan. Generally, the more points you pay, the lower your mortgage interest rate.
Sources for More Information
- Consumer Financial Protection Bureau – A U.S. government agency that ensures banks, lenders, and other financial companies treat consumers fairly.
- Investopedia – A website that focuses on investing and finance education along with market news and recommendations.
- Bankrate – A platform to help you make smart decisions with your money, offering in-depth financial advice, tools, and information.
- NerdWallet – A personal finance company that offers advice about paying for college, buying a home, retiring, and everything in between.
