Mortgage Basics: Interest Rate vs. APR [Video]

My Home May 04, 2017
 

If you’re new to the home loan process, you might be surprised to see two different rates on your mortgage agreement: your interest rate and your annual percentage rate (APR). That duality is commonly misunderstood. While it’s almost always desirable to shop for the lowest possible interest rate, there is some strategy involved in choosing your APR based on the term of your loan.

How is it possible for two different rates to affect the outcome of your loan? Let us explain.

Your interest rate
This number reflects the costs you’ll incur for borrowing the principal loan amount on the property. This is the rate used to calculate the monthly principal and interest payment. Interest rates are driven by the economy, such that home buying tends to spike when interest rates are low and drop when interest rates are high. But the interest rate is not the only factor in your monthly mortgage payments; property taxes, homeowners insurance, mortgage insurance and association dues can affect your monthly payments even more. 

Your annual percentage rate (APR)
The rate usually advertised and quoted by lenders represents the APR. That percentage signifies the broader annual cost of your loan when factoring in additional fees associated with settlement and closing costs over the course of each year. In the interest of full disclosure, lending institutions are required by law to reveal the APR to their clients; details are often found in the loan documents that your Mortgage Loan Officer provides you. Note that your APR is subject to change under the agreements within an adjustable-rate loan, just as your adjustable interest rate would be. 

A lower APR translates into lower interest rates. However, sometimes a loan offering a lower APR requires you to pay mortgage points or other fees. One mortgage point is equal to 1 percent of your loan amount, and such payments serve as prepaid interest that effectively “buys down” your overall interest rate and shrinks your monthly payments. The buying of mortgage points is most common with fixed-rate mortgages, and with adjustable-rate mortgages it only provides a discount on the fixed period of the loan.  

If you'd rather use that money toward a down payment or to buy appliances and furniture for your new home, you might look for a loan with a slightly higher APR that doesn't have those requirements. Try our mortgage calculator to help figure out which terms may be best for your needs.

In short, the longer you live in your new home, the greater the likelihood you’ll reach a break-even point at which the interest you save compensates for your initial cash input.

Visit U.S. Bank on the web to find listings of current interest and APR rates.

To learn more about the loan approval process, watch the other videos in this series entitled: 

Mortgage basics: 3 key steps in the home buying process
Mortgage basics: Finding the right home loan for you
Mortgage basics: Pre-qualified vs. pre-approved – What do I need?