# APR vs. Interest Rate: What’s The Difference?

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No one wants to pay more than they need to on a mortgage loan or refinance. That’s why it’s important to understand the difference between annual percentage rate (APR) and interest rate.

Interest rate is like a pizza — minus all the fixings. It’s shown as a percentage and gives you a way to gauge your monthly costs. APR, on the other hand, is the yearly cost of a loan. It’s also shown as a percentage, but it includes all the fixings such as mortgage insurance, discount points, origination fees, mortgage broker fees, and some closing costs. In that way, APR actually gives you a much clearer idea of what you’re paying.

For example, you might find a 4.5% interest rate on a mortgage rate, but once you add in all the extra fees, the APR becomes 4.6% or 4.7%.

The Truth in Lending Act (TILA), enacted in 1968 by the federal government, requires lenders to divulge credit terms easily understood for the borrower. That way, consumers can comparison shop rates and determine the affordability of a loan. It puts you in charge and gives you the leverage to make more informed decisions.

Consumers use both APR and the interest rate to determine the cost and affordability of a loan. So why do lenders advertise both an APR and an interest rate? Which one should you pay attention to?

## What Is An Interest Rate?

Interest rates are typically determined by a borrower’s credit score and prevailing rates–i.e., the average interest rate currently charged on mortgage loans by lenders. Your monthly payment is based on the principal balance and interest rate, not the APR.  Your interest rate is usually based on your credit score, so the higher your credit score, the better your interest rate. The interest rate is only the interest paid to the lender.

Mason Miranda, a credit industry specialist with Credit Card Insider, located in Syracuse, New York, defines interest rate this way: “An interest rate is a charge for borrowing a principal loan amount over a period of time is always expressed as a percentage. It can be variable, with the possibility of changing over the life of the loan, or fixed, which it means will stay the same over the life of the loan.”

Today, as you and millions of other Americans grapple with the realities of COVID-19, mortgage interest rates have dropped, offering a bit of good news for prospective homebuyers and current homeowners who want to cash in on these low rates by refinancing

### Pro Tip

When comparing lenders, pay attention to the APR, which is the real cost of financing.

## What Is An APR?

APR is fixed by the lender and includes lender fees and other costs that vary from one lending institution to the next. It gives borrowers a more realistic picture of what a loan will cost them. APR is not related to your monthly payment, which is calculated using only the interest rate.

“APR is broader and typically a bit higher because it is the annual cost of the loan to the borrower including fees and one-time costs like mortgage insurance, closing costs, loan origination fees, broker fees, etc.,” says Michael Foguth, founder of Foguth Financial Group, a financial planning agency in Michigan. “The APR is required by law to be disclosed on the loan agreement. Your monthly payment, however, is based on the interest rate on your loan.”

APR should be used when comparing total costs of loans, Foguth says.

Keep in mind, though, that the APR may not include every fee, such as appraisal, inspection and credit reporting fees. When comparison shopping, it’s always a good idea to ask your lender what is and what is not included in the APR they quote so you have an accurate picture of all the costs of buying a home.

## Interest Rate vs. APR

Interest rates and APRs both give you a sense of how much you’ll pay on a loan, but there are some key similarities and differences. These are a few key factors that are unique to interest rates and APR:

Interest Rates

• Helps you calculate monthly costs
• Does not include fees and other one-time costs
• A lower number than the APR

APR

• Helps you calculate yearly costs and overall costs
• Includes most fees and one-time costs
• A higher number than the APR

Here are some things that are common to both interest rates and APRs:

• Expressed as a percentage
• Lenders are legally required to disclose the interest rate
• Can vary depending on the lender and your creditworthiness

## How the Length of Your Loan Relates to APRs and Interest Rates

In addition to the interest rate and APR, the length of the loan also matters when it comes to how much you’ll pay over the life of the loan. All other conditions being equal, 15-year loans tend to have lower interest rates and APRs than 30-year loans. But you’ll also pay less interest in total because you’re paying off the loan in a shorter time frame.