Taking out a mortgage loan often involves deciphering a lot of financial jargon that you have never had to understand before. Interest rate and annual percentage rate (APR) are two of the most confusing terms for a lot of people, because they seem to be talking about the same thing.
While the interest rate and annual percentage rate are similar, and are both ways of determining the cost of a mortgage loan, they are different and that difference matters. That difference is rarely clear to the layman, however, and often mortgage professionals have a hard time explaining it in a way that is easy to understand. Learn more about the difference between mortgage interest rate vs APR.
Mortgage Interest Rate
Simply put, the interest rate is the cost of borrowing the loan. This is what the lender is charging you, calculated as a percentage of the total loan amount. That percentage, in turn, is based on your credit score. The better your credit, the lower the interest rate you get.
The interest rate is best used as a way to gauge your monthly costs. Each mortgage payment includes a payment on the principal (the amount you borrowed) and the interest (what you are being charged for the loan by the lender). So, a higher interest rate will translate to higher monthly payments.
Annual Percentage Rate
Annual percentage rate includes lender fees and other costs that are determined by the lender. Much like the interest rate, this is a way of expressing how much it costs to take out the loan. The difference is that the interest rate tells you what your monthly costs will be, while the APR tells you what the yearly cost will be. Because lender fees and other costs are included in the APR, there will be more variability between lenders on annual percentage rates than on interest rates.
Why You Need To Know Both
Interest rate tells you the monthly cost of the loan, while annual percentage rate tells you the overall cost of the loan. You may have noticed that with credit cards there is usually no difference between APR and interest rate, because credit cards are meant to be paid off regularly.
With a mortgage, the difference in the two numbers matters because of the length of time that it takes to pay off the loan. Remember, the interest rate really only describes the monthly payments. This is important; you need to know if you can afford those. The APR, meanwhile, will help you understand the overall cost of the mortgage.
Choosing a mortgage with the lowest APR only makes sense if you are staying in the home for decades, because the APR spreads the cost of the fees over the entire course of the loan. Lower APR means you pay more of the fees up front, reducing the costs later on. If you are not planning to stay in the home for more than a few years, if would make more sense to pay fewer fees up front and get a higher APR because you will end up paying less.
Comparing Mortgage Interest Rate vs APR
The amount of the loan you need will not change from lender to lender, so interest rate and annual percentage rate are really the only two numbers you have to compare one lender to another. Each lender should provide you with a full breakdown of the costs, including interest rate, APR, lender fees, estimated monthly payments, and the estimated total cost of paying off the entire mortgage.
Seeing the difference in the monthly payments and the total costs is often one of the best ways to understand how interest rate and APR affect your mortgage payments. You will notice that lower interest rates and APR usually result in a lower monthly payment, with more fees paid up front. This means you are essentially front loading the cost of the mortgage to some extent. You will pay more early on, and the overall cost of the mortgage will be lower.
Higher interest rates and APR come with much lower fees to be paid up front, because the cost is spread out over the duration of the mortgage. You will end up paying more in the long run, although the difference may not be significant compared to the total cost of the mortgage. You will have a high monthly payment, though.
Interest rates will likely be very similar between all lenders, because they are based on the market and one your credit score. The APR is what will change from one lender to another, and so when you are comparing different lenders, the APR becomes the more significant number.
If you would like more information or more clarification on mortgage interest rates and annual percentage rates, or if you would like to inquire about other mortgage services, contact Fairfax Mortgage Investments today.