APR vs. interest rate

Every mortgage offer you look at shows two percentages, and they are almost never the same number. People assume the smaller one is marketing and the bigger one is the truth. That is not quite it. They measure different things, and each one is the right number for a different question.

The short version

Your interest rate is the cost of borrowing the money. Your APR is that same rate with most of the lender’s costs folded in and the whole thing re-expressed as a yearly percentage. That is why APR is usually the higher of the two.

What the interest rate actually does

The interest rate is applied to your loan balance, and it is what your amortisation schedule runs on. It determines the principal-and-interest portion of your monthly payment, and it is the number written on your note. If you want to know what you will pay each month, the interest rate is the number that answers you.

Nothing else in the deal changes that payment. Points, lender fees, and title costs are paid at closing or financed into the balance; they do not appear in the interest rate.

What APR is for

APR exists because of the federal Truth in Lending Act, which requires lenders to disclose the cost of credit on a common basis so that offers can be compared. It takes the interest rate and adds the lender’s finance charges — origination charges, discount points, mortgage insurance where it applies, and certain prepaid items — then spreads them across the full loan term and restates the total as an annual rate.

So the gap between the two numbers tells you something useful on its own. A wide gap means a lot of upfront cost is baked into the loan. A narrow gap means comparatively few lender charges. Two offers quoting the identical interest rate but different APRs are not the same offer.

Where APR quietly misleads

• It assumes you keep the loan for the entire term. This is the big one. The calculation spreads your upfront costs over all thirty years. Most people sell or refinance long before then. When that happens you paid those costs over a far shorter period than the maths assumed, which means the loan with the lower APR can easily be the more expensive loan for you.
• On an adjustable-rate loan it is a projection. APR has to assume something about how the index behaves years from now. Treat it as an estimate, not a measurement.
• Lenders do not all include the same charges. Some third-party costs you are allowed to shop for may or may not land inside the calculation, so two APRs are only truly comparable when the underlying fee structures are.
• It says nothing about your payment. Budgeting from APR overstates what leaves your account each month.

How to compare two offers properly

1. Get the Loan Estimates on the same day. Mortgage pricing moves, so quotes from different days are not comparable no matter how carefully you read them.
2. Make sure they describe the same loan: same amount, same program, same term, same lock period, same occupancy.
3. Compare Section A, origination charges, line by line. This is where lender cost actually lives.
4. Look at discount points separately, and ask for the same loan priced with and without them. Points are a prepayment of interest, and they only pay off if you keep the loan long enough to recover what you paid.
5. Compare cash to close.
6. Then glance at APR as a sanity check — a way to catch an offer whose low rate is hiding a lot of cost. Do not let it cast the deciding vote.