What’s the Difference Between APR and Interest Rate?

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APR vs. Interest Rate: Understanding the Difference

When you’re applying for a home loan, you’re likely to hear a lot about interest rates and annual percentage rates. The numbers can be confusing, but it’s important to understand how the two differ and how they affect your loan.

Interest rate and annual percentage rate (APR) often get confused. So, what’s the difference between interest rate and APR?

Understanding Interest Rates

Interest rate refers to the annual cost of a loan without any fees or other costs. It is the percentage cost for borrowing money, expressed as a percentage of the loan amount. A lower interest rate typically means lower monthly payments, while a higher interest rate means higher monthly payments. The interest rate can be fixed (meaning it remains the same over the length of the loan) or adjustable (meaning it can change periodically).

Understanding Annual Percentage Rate (APR)

Annual percentage rate (APR) is the amount of interest and fees you’ll pay to borrow money, stated as a yearly percentage. APR reflects the total cost of borrowing, providing a more comprehensive picture of the cost of the loan. Unlike interest rate, APR takes into account additional costs such as closing costs and loan origination fees. Because of this, it’s typically higher than the interest rate.

Example: Interest Rate vs. APR

Let’s say you’re applying for a $200,000 mortgage with a 30-year term.

• The lender offers you an interest rate of 5%. Your monthly principal and interest payment will be calculated based on this rate, resulting in a monthly payment of about $1,073.64.
• However, the loan also includes additional costs like a $3,000 origination fee and $1,500 in closing costs. When these costs are factored in, the APR is 5.37%.

In this example, your monthly payment is based on the 5% interest rate, but the true cost of the loan is higher (5.37%) because it includes the extra costs of borrowing. The APR gives you a more complete view of the cost of the loan over time, which can help you make a better comparison between different loan offers.

The Bottom Line

The key difference between interest rate and annual percentage rate is that APR includes the interest rate plus any other fees and costs associated with the loan, while the interest rate only reflects the cost of borrowing the principal balance of the loan.

When you’re shopping for a loan, it’s important to keep in mind that an advertised interest rate isn’t the same as your loan’s annual percentage rate (APR). Your monthly payment will be based on the interest rate, not the APR.

The Truth in Lending Act (TILA) requires lenders to disclose both the interest rate and the APR to borrowers. You’ll find this information included in the loan estimate and closing disclosure. Be sure to compare both the interest rate and the APR to get the full picture and make an informed choice that aligns with your financial situation and goals.