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Interest vs. APR: What’s the Difference?

2022-11-15T15:58:18-06:00Home Ownership|

If you’ve been shopping for a home loan, you may have noticed that mortgage lenders sometimes advertise both an interest rate and an annual percentage rate (commonly abbreviated to “APR”) when referring to their loans. Knowing the difference between the APR and interest rate — and how each can impact the total cost of the money you intend to borrow — is wise.

So, what’s the difference between interest and APR? This blog will provide a basic definition of mortgage interest rates and APR, outline the differences between the two, and help you understand why these numbers matter when picking a mortgage.

What is an interest rate?

An interest rate is defined as the cost the lender charges to borrow their money, expressed as a percentage of the principal (the “principal” being the amount of money loaned before interest or fees). Banks, credit unions, and other lending institutions add interest to their loans to cover the risks and costs incurred by lending funds.

In essence, interest is a financing fee paid by the borrower for the convenience of borrowing money.

Depending on the lender and the type of mortgage loan, you may encounter “fixed” or “adjustable” interest rates. A fixed-rate mortgage means the interest stays the same for the duration of the loan. An adjustable-rate (or variable-rate loan), on the other hand, carries an interest rate that can change.

What is APR?

In addition to the interest rate, mortgage loans will also have an advertised “annual percentage rate,” commonly abbreviated as “APR.” This will also be expressed as a percentage, just like the interest rate.

The APR of a loan is the interest rate in addition to any fees or associated costs. Common mortgage fees might include closing costs, brokerage fees, origination fees, or private mortgage insurance.

Because the APR looks at the interest rate plus any additional fees and costs, it is commonly understood to be a more complete picture of the total cost of a loan.

Which is better: a lower APR or a lower interest rate?

When shopping for a loan, the APR is a more accurate number to use when comparing products.

At first glance, a low interest rate may seem enticing. However, additional costs (e.g., closing costs, insurance, etc.) may drive up the APR, making the loan more costly in the long run when compared to a loan with a higher interest rate but an overall lower APR. And a higher APR means you have a higher monthly payment — and you pay more interest over the life of the loan.

Next time you’re looking to borrow funds, remember that while it’s key to know both the interest rate and the APR, the APR is the number that provides a complete, bottom-line number and is, therefore, more useful when comparing the total cost of a loan.

Looking for more help understanding mortgages?

Mortgages are complex. If you’re in the market for one, schedule a call or video chat with the Mortgage experts at Connexus. Our team will help you understand the product and ensure you’re choosing the right home loan for your family.

The Connexus Credit Union blog also covers Mortgage topics, homebuyer resources, and other helpful information to help make home loans a little less daunting. Take a look through our list of helpful articles today.

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