Key takeaways

  • The interest rate determines your monthly principal-and-interest payment.
  • The annual percentage rate (APR) adds certain upfront costs, such as points and many lender fees, and expresses the total as a yearly rate. It is usually higher than the interest rate.
  • APR assumes you keep the loan for its full term. If you expect to sell or refinance sooner, upfront costs weigh more heavily than the APR suggests.
  • Compare offers from the same day, for the same loan type, term and lock period.

Every mortgage offer shows two percentages that look alike and are easy to confuse. They answer different questions. The interest rate tells you what your monthly payment will be. The APR tries to tell you what the loan really costs once certain fees are counted. Knowing the difference is one of the simplest ways to compare offers well.

The interest rate: the price of the money

The interest rate is the annual percentage a lender charges on the balance you owe. Together with the loan amount and term, it sets your monthly principal and interest payment. On a Loan Estimate it appears on the first page, next to the loan amount and the monthly payment.

What the interest rate does not show is how much you paid up front to get it. Two lenders can quote the same rate while charging very different fees, and one can quote a lower rate because it expects you to pay more at closing.

The APR: a broader measure of cost

The APR is required by the federal Truth in Lending Act. It combines the interest rate with certain finance charges and expresses the result as a single yearly rate. On the Loan Estimate you will find it on page three, in the section headed Comparisons.

What APR generally includes

  • Interest over the life of the loan
  • Discount points paid to lower the rate
  • Loan origination and many other lender charges
  • Mortgage insurance premiums, in many cases

What APR generally leaves out

  • Some third-party charges, such as appraisal, credit report and title-related fees
  • Ongoing costs such as property taxes and homeowners insurance

Because of those exclusions, APR is a comparison tool, not a complete price tag. You still need the Loan Estimate’s closing cost pages to see every dollar.

Points, credits and the break-even question

Discount points are fees you pay at closing in exchange for a lower rate. One point equals 1 percent of the loan amount. How much a point lowers the rate varies by lender and by day. Lender credits work in reverse: you accept a higher rate and the lender pays part of your closing costs.

Points make the most sense when you keep the loan long enough for the monthly savings to repay the upfront cost. That is where APR and real life can diverge.

Illustrative example: two offers on a $300,000, 30-year loan
Offer A: rate and upfront lender costs
6.50%, $1,500
Offer A: monthly principal and interest / APR
$1,896.20 / about 6.55%
Offer B: rate and upfront lender costs
6.25%, $4,500 incl. one point
Offer B: monthly principal and interest / APR
$1,847.15 / about 6.39%
Monthly difference
$49.05 in favor of B
Months to recover B’s extra $3,000
about 61, just over five years

Hypothetical offers with a simplified APR calculation, for illustration only. Real offers include other costs.

Offer B has the lower APR. But if you sold or refinanced within five years, you would have paid $3,000 for savings you never fully collected, and Offer A would have cost less. The APR cannot know your plans; you have to bring that part of the math yourself.

APR on adjustable-rate loans

For an adjustable-rate mortgage, the APR is calculated using assumptions about future rates that may not hold. It can make an ARM look cheaper or more expensive than it turns out to be. With ARMs, the caps and the maximum possible payment tell you more than the APR does. Our guide to fixed-rate and adjustable-rate mortgages explains how to test them.

How to compare offers fairly

  • Same day. Rates change often, sometimes more than once a day. Quotes from different days are not truly comparable.
  • Same loan. Match the loan type, term, loan amount and down payment.
  • Same lock period. Longer rate locks can cost more.
  • Same points. Ask each lender to quote with no points, or with the same number of points.
  • Read page two. Section A of the Loan Estimate, Origination Charges, shows what the lender itself is charging.

A quick check

If the gap between the interest rate and the APR is much wider on one offer than on another, the difference almost always comes from larger upfront fees or points. Page two of the Loan Estimate shows where they are.

The number many people skip

Next to the APR, the Comparisons section shows an In 5 Years figure: the total you will have paid in principal, interest, mortgage insurance and loan costs during the first five years, and how much principal you will have paid off. If there is a real chance you will move or refinance within five years, this figure can be more useful than the APR itself.

Helpful official resources

About this guide. OwnMG publishes general educational information. It is not financial, legal or insurance advice, and OwnMG is not a lender, insurer, broker or government agency. Rules, limits and fees change, so confirm current details with your lender or the agency involved. Spotted something out of date? Tell us at info@ownmg.com.