If you've always assumed that an interest rate and an APR (annual percentage rate) are synonyms for the same thing, rest assured you're not alone. Many people without a full grasp of the two definitions naturally assume the terms refer to the same type of expense. However, understanding the difference between both can help you keep your mortgage payment within budget. Here is an overview of the main differences between a mortgage's interest rate and APR.
Understanding Your Possible Mortgage Payment
Before taking on a mortgage, homebuyers should understand all of the costs that make up a mortgage payment. There are several distinct costs bundled into one amount you'll have to pay each month, including:
- The portion of the loan’s principal amount.
- The amount of interest due for the money you’ve borrowed.
- The homeowner’s insurance premium.
- A portion of the property taxes due annually on the property.
Why is Your Mortgage Interest Rate So Important?
The interest rate on your financing, which is determined by your credit score, can have a large impact on your mortgage payment and whether or not the bank will approve the purchase of your future home. Buyers who have a lower interest rate and APR can afford to purchase a home with a higher asking price, but the higher asking price will likely mean more interest payments in the end.
The Definition of an Interest Rate and an APR
Simply put, the interest rate determines your monthly interest payment, which is the amount you are paying to the bank to borrow the money. By including the interest amount, the APR is similar but also adds the cost of broker fees, closing costs, and any other fees included in the loan. Certain lenders offer rebates or discounts on the loan, and these amounts are typically deducted from the APR rate. While the interest rate might have more of an effect on how much you will pay in the short-term, the APR makes the biggest difference in how much you end up paying over the life of the loan.
How to Calculate the Interest Rate and the APR on Your Mortgage
There are many free online tools, like the one on calculator.net, to help you calculate the true cost of different interest rates and APRs on a mortgage before you sign on the dotted line. Figuring out these costs can mean the difference between whether or not the home you want is inside your budget.
The Impact of Interest Rates on a Home Purchase
Is it better to choose a loan with a low interest rate and high fees, or one with a higher interest rate but fewer fees? Calculating the APR will help you compare these two possibilities more directly. For example, if you are going to purchase a home for $100,000 with an interest rate of 7 percent and $1,000 in fees, your APR works out to 7.09 percent. A loan with twice as many fees carries an APR of 7.2 percent.
While the APR has more of an impact on how much you pay over the life of the loan, the interest rate on your loan will have a more immediate impact on your finances. Depending on the loan size, an increase of just a few basis points can result in the monthly payment being tens or hundreds of dollars more.
Important Considerations of an APR
If you're getting ready to purchase a home, remember that your financing decisions today will impact your budget for years to come. As you analyze the APR on a potential mortgage, at the forefront of your mind should be your long-term plans for the home. If you are only planning to live in the home for a few years, the APR won't have too much of a direct impact on how much you pay, so you should focus more on getting a lower interest rate. On the other hand, if this is going to be your forever home, having a higher APR will result in you paying more over time and it's likely worth your while to seek out a lower one.
With Clever, you can make your mortgage loan stretch even farther by saving more at closing. Contact a Clever agent today to learn about our $3,000 flat listing fee.