Interest rate and annual percentage rate (APR) are commonly interchanged due to the slight difference between their calculations. Nonetheless, they are different and important to understand when determining the cost of a loan.
Read on to learn more about the difference between interest rates and annual percentage rates and what each means.
Mortgage Interest Rates
Let’s start with breaking down your mortgage interest rate. The interest rate, also known as the advertised rate or nominal rate, is a percentage of your loan. This is paid on a monthly basis so long as you owe your loan. Essentially, this number represents approximately how much it costs to borrow the lump sum amount of money. You are compensating the lender for using their loan to purchase your property.
An example of this is if your loan is $400,000 and the interest rate of your loan is 6%, your annual interest expense would amount to $24,000 ($2,000 monthly). As you pay off the principal balance ($400,000), your monthly interest expense ($2,000) will decrease as well. Try another example or your situation using our mortgage calculator.
The interest rate is a cited number by the lender. Some factors that may influence interest rate include:
- Strength of the stock market
- Federal funds rate
- Employment levels
Outside of these external factors, each lender will have varying interest rates. Each lender has its own costs to compensate through an interest expense and considerations they may want to view. These may include:
- Employment and income
- Financial events (collections, bankruptcy, etc.)
- Down payment and loan amount
- Property type and location
Have a look at where you can get a personal loan and credit.
Annual Percentage Rates (APR)
The annual percentage rate is commonly higher than the interest rate. The APR includes the interest rate as a component in addition to any fees and costs associated with the loan. That makes this rate more important to understand as it gives you a broader picture of how much your loan will cost.
These additional fees and costs may include:
- Mortgage broker fees
- Closing costs
- Rebate fees
It is important to identify what is included in your APR to avoid hidden fees and from carrying more debt than you intended. Using the prior example of a $400,000 loan with 6% interest rate, let’s add $5,000 as additional fees making the final loan $405,000. This now makes your annual interest expense $24,300 (405,000 x 0.06). Taking the new annual interest expense and dividing it with the original loan amount (400,000) will get you the APR of 6.08%.
Annual Percentage Rate (APR) vs. Interest Rate
As you can imagine, with the APR consisting of additional fees with the interest rate, it is typically a higher number than your interest rate. While both rates are important to understand and consider, the APR gives you a bigger picture of what expenses to expect. A lower APR fee usually indicates fewer upfront fees and a better deal.
It can be confusing to choose a loan based on the two rates. Every mortgage situation is unique, depending on your current position, and the interest rates you may need a different suggestion. If you are interested in buying a home, The Mortgage Station experts can help guide you every step of the way.