It’s important to understand the difference between interest rate and APR if you’re buying a house and going through the mortgage loan process. You might think they’re interchangeable or that one is more important than the other, but they are equally important to consider when shopping for a loan.
Interest rate vs. APR
There’s a host of expenses involved with the loan process, including interest, points and fees. The interest rate is what you’ll pay each year to borrow the money for the loan, and nothing else.
The APR (annual percentage rate) is a rate that gives you a bigger picture of exactly how much you’re spending for the loan, because it includes all the extras. Expenses such as points, broker fees and some closing costs are all factored into the APR, meaning it will be higher than the interest rate.
Comparing fixed rates and adjustable rates
The interest rate, not the APR, is what dictates your monthly loan amount. When comparing rates, you might see one APR that’s higher than another, but the interest rate could still be lower. When considering the amount you’ll be paying month to month on a fixed-rate loan, the interest rate is what you’ll need to review.
The APR, on the other hand, is the whole shebang — what the loan will cost you, taking into account your monthly payment plus all the points, fees and costs associated with obtaining the loan. Those extra fees are folded into the loan.
When comparing loans, it’s important to consider the interest rate and the APR together. The APR shows what the entire cost will be because it includes all the points and fees. You might find one loan has a lower interest rate but a higher APR, or overall cost. Likewise, a loan with a higher interest rate might have a lower APR.
When you shop around for interest rates, get quotes on the same day, as interest rates can change from day to day. Also, when looking at the APR, take a hard look at what fees are included. You won’t always be comparing apples to apples. One lender might not include all the fees another lender does.
If you’re considering an adjustable-rate loan, the Consumer Financial Protection Bureau recommends keeping in mind that the APR of an adjustable-rate loan can be misleading because it doesn’t necessarily take into account the maximum rate of the adjustable-rate scale.
Prequalification
In addition to finding the best rates and understanding the difference between interest rate and APR, one of the best things you can do is get prequalified for a loan. The lender will review your income, credit history and debts to determine if you’re qualified for a mortgage loan. If you are, all those factors will play a role in determining what your interest rate will be.
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