What is the difference between the interest rate and the Annual Percentage Rate (APR)?

You'll see an interest rate and an Annual Percentage Rate (APR) for each mortgage loan you see advertised. The answer to "why" is that federal law requires the lender to tell you both rates.

The APR is a tool for comparing different loans, which will include different interest rates, but also for comparing points and other terms. The APR is designed to represent the "true cost of a loan" to the borrower, expressed in the form of a yearly rate. This way, lenders can't "hide" fees and front end costs behind low advertised rates.

While it's designed to make it easier to compare loans, it can be confusing because the APR includes some, but not all, of the various fees and insurance premiums that accompany a mortgage.  And since the federal law that requires lenders to disclose the APR does not clearly define what goes into the calculation, APRs can vary from lender to lender and loan to loan.

The APR on a loan tied to a market index, like a 5/1 ARM, assumes the market index will never change. But ARMs were invented because the market index changes and makes fixed rate loans cheaper or more expensive.

So, APRs are at best inexact. The lesson is that the APR can be a guide, but you need a mortgage professional to help you find the best loan for you. This is where we can help you!

Note that when you are browsing for loan terms, the APR for example will not tell you about balloon payments, pre-payment penalties, or how long your rate is locked. Also, you will see that APRs on 15-year loans carry a higher relative rate due to the fact that points are amortized over a shorter period of time.