What Is The Difference Between Interest Rates and APR?

What Is The Difference Between Interest Rates and APR?

To those who ask themselves life’s largest existential questions, they are courageous enough to consider queries like:

  • Who am I?
  • Is there life after death?
  • What Is the Difference Between an Interest Rates and an APR?

Well, for obvious reasons, the 3rd question would not be included in this self-reflective line of thinking, although most would agree that the difference between an Interest Rate and an Annual Percentage Rate (APR) is a rough concept to nail down.

Simply put, the Interest Rate and the Annual Percentage Rate are calculable measurements that reveal two significant, but different measures of a mortgage’s cost.

From Merriam-Webster’s perspective:

The Interest Rate: is the actual cost of borrowing, relative to the loan balance. Interest rates on loan balances are disclosed as either variable or fixed rates.

The Annual Percentage Rate: is a more comprehensive gauge of the cost of mortgage financing because the APR discloses the interest rate, but also includes other lending costs like:

  • Broker Fees
  • Discount Points
  • Closing Costs

Developing a viable understanding between an APR and an Interest Rate, could potentially save mortgagors thousands of dollars when financing their home.

EXAMPLE: The following chart reveals the specifics of three $200,000 mortgages with three different APRs. The first two lines of the chart discloses that the Interest Rate will decrease by ¼% for every 1.5 points paid. For a $200,000 mortgage, each point would 1% of the loan amount, or in this case, $2000.

Source:
Estrin, Michael. (2017, July 28). The difference between your mortgage rate and the annual percentage rate, or APR. Bankrate.com. Retrieved September 6, 2017, from http://www.bankrate.com/finance/mortgages/apr-and-interest-rate.aspx

The Take-away

If a homeowner in the market for a mortgage wishes to focus upon the monthly mortgage payment ONLY, the Interest Rate would be the measurement to use to compare potential mortgage loans.

But, if a homeowner wishes to compare the entire cost of various mortgage options throughout the life of the loan, the measurement to use would be the Annual Percentage Rate. However, the APR calculates the cost of the mortgage over the life of the loan, so according to the above chart, if you paid off a mortgage after only 3 years, it was imprudent to pay any points as the total cost of the ‘no-points’ loan option has the lowest cost of all three mortgage options, $39,281.

At ten and 30 years, however, paying points would be the most prudent path.

Compare Carefully. Seek expert advice. But, choose wisely!

Please speak to one of our experienced mortgage lenders with any questions or to get started on a new loan! Call (858) 693-1854 or email Patrick: patrick@morganhomefunding.com.