APR vs Interest Rate
Every loan offer shows two percentages that look almost the same and are not. Confusing them can cost thousands of dollars over the life of a mortgage, so it is worth pinning down exactly what each one measures and how to use them together.
Interest rate
The interest rate is the annual cost of borrowing the principal, expressed as a percentage. It is the number that drives your monthly payment: the amortization formula divides it by 12 and applies it to your balance each month. Nothing else about the loan — fees, points, closing costs — changes the interest rate itself. See how amortization works.
APR (annual percentage rate)
The APR starts with the interest rate and then adds most of the loan’s mandatory borrowing costs — lender origination fees, discount points, mortgage broker fees, and some third-party closing costs — and re-expresses the whole package as a single yearly rate spread over the full term. Because it includes those costs, the APR is always equal to or higher than the interest rate.
APR exists precisely so borrowers can compare offers with different fee structures on one number, and US lenders are required to disclose it under the Truth in Lending Act. On your Loan Estimate, the interest rate is on page 1 and the APR is on page 3.
Why the gap matters: a worked comparison
Two mortgage offers on a $320,000 loan:
| Offer A | Offer B | |
|---|---|---|
| Interest rate | 6.25% | 6.50% |
| Discount points & lender fees | $9,000 | $1,500 |
| Monthly P&I | ~$1,970 | ~$2,023 |
| APR | ~6.45% | ~6.57% |
Offer A has the lower rate and the lower APR, so over the full 30 years it is cheaper — you save about $53 a month, roughly $19,000 in payments over the term, for $7,500 more up front. The extra upfront cost pays for itself in about 12 years ($7,500 ÷ $53 ≈ 142 months).
If you are confident you will keep this exact loan for 15+ years, Offer A wins. If there is a real chance you will move, refinance, or pay it off within, say, seven years, Offer B is the better deal despite the higher rate and APR, because you never recover that $7,500.
The same comparison, shorter horizon
Suppose you are almost certain to sell in five years. Over 60 months, Offer A saves 60 × $53 = $3,180 in payments — but you paid $7,500 extra at closing for the lower rate. You are about $4,300 worse off with the “cheaper” loan. The lower APR was the wrong signal for your situation.
Discount points, explained
A discount point costs 1% of the loan amount and typically buys down the rate by about 0.25% (it varies by lender and day). On a $320,000 loan, one point is $3,200. Whether points are worth it is the same break-even question:
break-even months = point cost ÷ monthly payment reduction
Pay points only if you will keep the loan well past that break-even and you are not draining reserves you will need. Lender credits are the reverse — the lender pays some of your closing costs in exchange for a higher rate, which can be the right move when cash is tight or the horizon is short.
What APR does not capture
- How long you actually keep the loan. APR is calculated as if you hold it for the entire term. Pay it off or refinance early and the upfront fees are spread over fewer years, so your effective annual cost is higher than the quoted APR — sometimes much higher.
- Costs the lender is allowed to exclude. Appraisal fees, title insurance, recording fees, home inspection, and prepaid escrow for taxes and insurance are often left out of the APR calculation even though you pay them at closing.
- Different lender assumptions. Lenders have some latitude in which fees they include, so two APRs are not always computed identically. The itemised fee list is the ground truth.
- Adjustable-rate resets. For an ARM, the APR is an estimate that assumes today’s index holds. After the fixed period your real cost depends on rates.
- PMI. Mortgage insurance is generally excluded from APR, even though it can add $100–300+ to your monthly payment until you reach 20% equity. See PMI explained.
How to use both numbers
- First pass — compare APR to APR across at least three lenders, requested on the same day for the same loan amount and term. It is the fastest way to see past a teaser rate with heavy fees.
- Second pass — get the fee itemisation (Loan Estimate page 2). Separate the fees you can shop for (title, settlement, some services) from the ones you cannot (recording, transfer taxes). Section C fees are shoppable.
- Third pass — be honest about your time horizon. Divide the extra upfront cost of the lower-rate offer by the monthly saving to get a break-even in months, and compare that to how long you realistically expect to keep the loan.
The refinance calculator does exactly this break-even math for a refinance, and the same logic applies when choosing between two purchase offers.
Common mistakes
- Comparing one lender’s rate to another’s APR. Always compare like to like.
- Assuming the lowest APR is always cheapest. It is cheapest only over the full term. Over a short holding period, a low-fee, higher-rate loan often wins.
- Shopping over several weeks. Multiple mortgage inquiries within a ~14–45 day window count as a single hard inquiry for credit scoring; spreading them out over months can ding your score repeatedly.
- Chasing the headline rate. A 5.99% rate with $15,000 in points is not a good deal for most buyers.
- Ignoring the “no-closing-cost” trick. There is no free refinance — those costs are financed into a higher rate or a higher balance.
The bottom line
The interest rate sets your payment; the APR estimates your all-in annual cost including fees, assuming you keep the loan for the full term. Compare APRs to cut through fee games, then adjust for how long you will really hold the loan — the shorter your horizon, the more a low-fee loan beats a low-rate one, and the less sense discount points make.