Understanding the Difference Between Interest Rate and A.P.R.
When shopping for a mortgage, it’s easy to be drawn to offers with low interest rates and A.P.R.s. But what do these terms mean, and why is it important to understand the difference?
Interest Rate
The interest rate is simply the cost of borrowing money, expressed as a percentage of the loan amount. It determines your monthly payment for the loan but doesn’t include other costs, like fees or closing costs.
A.P.R. (Annual Percentage Rate)
The A.P.R. gives you a broader view of the loan’s cost because it includes the interest rate plus some additional fees and expenses, such as:
- Loan origination fees
- Discount points
- Certain closing costs
A.P.R. is meant to help borrowers compare loans by factoring in these extra costs. However, it’s not perfect and has some key flaws:
Why A.P.R. Can Be Misleading
Assumes No Early Payoff
A.P.R. assumes you’ll keep the mortgage for the full term (e.g., 30 years). In reality, most people sell, refinance, or pay off their mortgage within 4–7 years.
Ignores Inflation
A.P.R. treats a dollar today as if it’s worth the same in 10, 20, or 30 years, which isn’t realistic.
Overlooks Tax Implications
Fees and points may not be tax-deductible, but interest payments often are. A.P.R. doesn’t account for these differences, which could impact your finances.
Varies Between Lenders
Federal law requires lenders to disclose the A.P.R., but it doesn’t clearly define how to calculate it. As a result, A.P.R.s can vary widely, even for similar loans.
Doesn’t Account for Opportunity Cost
Money spent on upfront fees or points isn’t considered. For example, if you pay thousands in fees to lower your interest rate, A.P.R. doesn’t reflect what you could have done with that money instead.
The Bottom Line
While A.P.R. can be a helpful tool for comparing loans, it’s not always reliable. A low A.P.R. doesn’t necessarily mean the loan is the best fit for you.
To truly find the right loan, it’s essential to look beyond the numbers and consult a knowledgeable mortgage professional who can help you weigh all the factors.