An Explainer on Interest Rate and APR

Weighing your mortgage options? Before making any big decisions, make sure you’re not comparing apples to oranges.

Mortgage rates can be expressed as two different percentages: a nominal interest rate or an annual percentage rate (APR). And while the numbers may look similar on paper, the costs they represent can be significantly different.

Let’s define the terms and put them into proper context.

Interest Rate vs. APR
Interest rate is the percentage a lender charges on the principal balance of a loan annually. APR is the percentage a lender charges on the principal balance of a loan — plus all additional upfront costs. Since the total includes origination fees, broker fees, points and closing costs, the loan amount is technically larger and the APR is typically higher.

While the interest rate applies only to the principal balance, APR reflects the total cost of the loan. Both numbers are important, but APR provides a clearer picture of what you’ll actually pay over time.

Illustrating the Difference
The actual formulas for calculating interest and APR can get quite complicated, but free online calculators can provide a general estimate. Consider this simplified example:

If you purchase a $375,000 home with a 20% down payment ($75,000), your principal loan balance would be $300,000. At 6% interest with fees of $6,800, the APR on a 30-year loan would be approximately 6.215%.

Six percent interest on $300,000 is $18,000 annually, but at 6.215% APR, the amount increases to $18,645. At a glance, that’s not a significant difference, but over a 30-year loan term the costs can really add up.

Compare Carefully
Thanks to the Truth in Lending Act (TILA), lenders are required to disclose both the interest rate and APR on mortgage loans. This information should be listed in each Loan Estimate.

Any questions? Reach out today for helpful answers.