If you are shopping for a mortgage loan or looking to refinance your house, it’s all about a good mortgage rate. The interest rate on a home loan has a tremendous impact on how much you actually pay for the house. This is why homebuyers go to great lengths to get the best rate. Some even delay buying or refinancing a house until interest rates decrease, which maximizes their savings. Meanwhile, others give their personal credit history a complete overhaul to qualify for a better rate.
But it isn’t enough to recognize the importance of getting a low interest rate on your mortgage loan. As a savvy shopper, it pays to know the differences between your interest rate and your annual percentage rate. If you do not know a lot about financing, you may assume that the interest rate and APR are the same. There are differences between the two, and understanding what is APR and what is an interest rate is essential when comparing your loan options. This is the best way to compare costs across multiple lenders.
What is APR vs. Interest Rate?
Purchasing a home often requires acquiring funds from a bank. Without banks, most people wouldn’t be able to buy homes, cars or get a college education. Banks are eager to lend money to qualified applicants, and like any other business, lenders also want to make money. For this matter, you can think of interest as the bank’s fee. Interest is a percentage of the mortgage total, which is due each month with your mortgage payment. It’s essentially the price you pay to borrow funds over a period of time.
So, what is APR? The annual percentage rate, on the other hand, refers to the cost of the loan on a yearly basis. These terms – interest and APR – are not synonymous, but they are related. Both are expressed as a percentage. But while the interest rate is the cost of borrowing money, the APR includes interest and other fees.
Talk to anyone who has purchased a house and they’ll tell you about mortgage-related fees. Buying a home is one of the most expensive transactions, and unfortunately, the costs don’t stop with the purchase price. When you receive a mortgage loan quote, the lender will list the interest rate and the APR. The annual percentage rate is typically higher than the interest rate, as this rate takes into account the total cost over the life of the loan.
In addition to your interest rate, the APR includes:
- Origination fees: This is the mortgage lender’s fee for processing and underwriting a loan application, typically 1% of the loan balance.
- Discount points: This is a fee (pre-paid interest) borrowers pay to reduce their mortgage interest rate. A single point is equal to 1% of the loan balance, and each point reduces the interest rate by .25%.
- Private mortgage insurance: This insurance protects mortgage lenders in the event of default, and it is required if a borrower puts down less than 20%.
- Other closing costs: Other mortgage-related fees are calculated into the APR, such as the title search, attorney fees, escrow fees, and recording fees.
When shopping for a mortgage, the annual percentage rate helps you compare lenders and assess the true cost of borrowing.