You’ve probably heard the term “annual percentage rate” (APR) when weighing different options for mortgage loans. It’s crucial to understand what this rate represents and how it is different from an interest rate. Ultimately, an APR will give you a much more accurate estimate of the real cost of borrowing. An APR can apply to credit cards as well. According to creditcards.com, the average APR on new credit card offers for the week of May 27, 2020, was 16%, which was 1.72 percentage points lower than the record high this rate reached in May 2019. Let’s closely examine the difference between these two types of rates.
Both Are Annual
One of the few similarities between an interest rate and an APR is that both are annual. A mortgage typically features a principal (the amount you borrow) and an interest rate, which represents the cost of borrowing. Mortgage loans can have varying terms and durations, but the interest rate that one carries usually applies to a year. Now, here are some of the major differences between these two rates.
Cost Of Loan To Borrower
An interest rate represents the percentage that a lender charges you for borrowing from them. An APR, on the other hand, reflects both the interest rate and any additional fees you directly pay your lending institution or broker (or both). We will take a closer look at these extra fees soon.
Difference Between The Two Interest Rates
Given the fact that an APR includes added fees, it is higher than an interest rate. An APR will generally give you a much better idea of which borrowing option is the most sound one to take. An interest rate is typically determined by factors such as the Federal Reserve’s federal funds rate, trends in the banking industry, and your credit score as a borrower. If you have a high credit score and stable employment, the interest rate you pay will likely be relatively low. Furthermore, your monthly mortgage payment is based not on the APR, but rather on the interest rate and principal balance.
Meanwhile, the lender determines the APR. The Federal Truth in Lending Act dictates that the APR must be disclosed in every consumer loan agreement.
APR Includes All Fees
Among some of the most common fees included in an APR are origination charges and discount points. An origination fee is charged upon entering into a loan agreement in order to cover the cost of processing the loan. Discount points can help you lower your interest rate and potentially your monthly payments as well.
Here is an example that illustrates how the total fees you ultimately owe can vary depending on factors such as interest rates and APR.
Let’s pretend you are considering two offers on a $100,000 loan for 10 years:
- Loan A: With this option, you can borrow $100,000 with an interest rate of 3.25%, pay an origination fee of 1% (with no discount points), and $1,000 in other fees. If the origination fee costs $1,500, then you pay a total of $2,500 in fees.
- Loan B: You pay a discount point to lower the interest rate. For this offer, you could borrow $100,000 with a 3% interest rate and pay a 1% origination charge, 1 discount point, and $1,500 in other fees. Assuming the origination fee costs $2,500 and the discount point costs $1,500, then you end up paying a total of $5,500 in fees.
Loan B comes with higher fees but will likely have a lower APR. This means that you will ultimately pay less over the mortgage’s 10-year lifespan after including principal interest and other charges paid upfront.
More Information On What You’re Paying
For more information on exactly what you’re paying for and how much you’re spending, be sure to speak to your lender and broker and any other entity who is highly knowledgeable about interest rates and APR. They should be able to clearly outline all your options and let you choose one carefully.
Contact Mathis Title For More Info On What Is The Difference Between Interest Rates & APR
Reach out to the professionals at Mathis Title Company in Fairfax, Virginia, to learn more about the differences between interest rates and APR. We offer a variety of real estate services, including contract preparation and review (i.e. drawing up purchase agreements), mechanics liens, refinancing, settlements, and title insurance.
Robin Mathis is an attorney with more than 30 years of experience in real estate settlement and is highly knowledgeable about both the buyer and seller sides of these types of transactions. Also, our experienced title agents have a keen ability to spot errors in documents. Call Mathis Title Company today at (703) 214-4020 or contact us online for more information about our work or to schedule an appointment.