If you've ever wondered what the difference is between APR and interest rate, you're not alone. Read on to learn the basics of annual percentage rates (APRs) and interest rates so you can understand how the two compare.
Interest Rate Basics
All loan types, including mortgages, have an interest rate. This figure equals your cost each year to borrow the loan amount. The interest rate, which is reflected as a percentage, is the number used to calculate your monthly loan payment.
When it comes to mortgages, interests can either be fixed or fluctuate over time. Fixed-rate mortgages are available in 10-, 15- and 30-year terms. The shortest mortgages typically come with the lowest interest rates, but since the time frame is compressed, the monthly payments are much larger.
Adjustable-rate mortgages (ARMs), on the other hand, are generally available with a number of different terms. With these mortgages, the interest rate is often fixed for a certain period of time, after which the rate adjusts regularly.
What is an APR? An interest rate is relatively straightforward, but an APR is a bit more complicated. A mortgage APR factors in the loan's interest rate, broker fees, closing costs, discount points and other related charges. As a result, a loan's APR is higher than its interest rate, but the APR is a more comprehensive calculation.
How APR & Interest Rate Compare
When you shop around for mortgages or other loans, it's easy to focus on the interest rate and use that figure as your point of comparison. After all, interest rates tend to get the most press. If you've done your research, you probably know what interest rate you want when you first approach a lender. When you look at all the moving parts of a loan, however, the interest rate only offers part of the picture.
Ultimately, the APR offers a more complete picture of your annual cost of borrowing a particular amount of money. Not only does the APR bundle the interest rate, insurance costs and loan-related fees into a neat package, but it does so according to the Federal Truth in Lending Act. This piece of legislation requires all consumer lenders to calculate the APR accurately and disclose that APR to consumers.
All in all, both the interest rate and the APR are important for understanding a mortgage or a loan. On the one hand, the APR reveals the total loan cost, which is critical for shopping around and making sure you secured the best deal. On the other hand, the interest rate indicates what you'll be responsible for paying each month, which is important for budgeting purposes. Your long-term and short-term financial goals, along with your current financial situation, might sway you in favor of one over the other.
For more detailed information on APRs and interest rates, including loan terms currently available, you'll want to contact experienced mortgage lenders. Whether you need to refinance an existing loan or purchase your first home, mortgage lenders can advise you about your options.