Interest rate vs APR mortgage

When looking to secure a mortgage on a property, it is vital that you consider all of your options carefully. The interest rate vs APR are two terms that tend to be used interchangeably, yet it’s important that you know the difference between the two when you are mortgage hunting.

While they may be similar in terms of concept, the calculations aren’t the same. When you are assessing the cost of a loan, it is vital that you understand this so you know exactly how much you are going to end up repaying.

With that being said, let’s take a look at both in further detail so you can get a better understanding.

Interest Rate

The nominal interest rate, which is the advertised rate, is used when determining the interest cost on your mortgage. The Federal Reserve, also known as the Fed, sets the federal funds rate, and this can influence the interest rate. In this context, the federal funds rate refers to the rate at which banks can land reserve balances to other banks overnight. For instance, the Fed will usually reduce the federal funds rate during periods of recession to encourage people to spend money and raise the rate during inflation.

APR

Now that you know what the interest rate is, let’s take a look at APR. This is the more effective rate to consider when you are comparing different home loans.

The APR will incorporate both the interest expense (as described above) and all of the other costs and fees that are involved in procuring the loan. These fees can include discount points, rebates, closing expenses, and broker fees. These are typically displayed in percentage form.

Your APR should always be equal to or greater than the nominal interest rate, with the only exception being if you managed to agree on a special deal with the lender whereby they offer a rebate on some of your interest cost.

Ultimately, the APR is a broader measure of the cost of borrowing money when compared with the interest rate.

Truth in Lending Act

The 1968 TILA - Truth in Lending Act - has mandated that lenders disclose the APR charged to borrowers.

As another example, credit card businesses are also allowed to advertise interest rates per month, yet they do need to make sure that the APR is clearly reported to consumers before an agreement is signed.

You can calculate APR by multiplying the periodic rate of interest by the number of periods within a year in which it was applied. It does not indicate the number of times the rate is actually applied to the balance.

Different APRs but the same monthly payments?

This is the sort of scenario that ends up confusing borrowers the most. They received two deals, from two different lenders. They both offer the same monthly payments and the same nominal rate, yet the APR is different. How can this be possible?

Well, it will mean that the lender with the lower APR is offering a better deal and is demanding fewer upfront fees.

Interest rate vs APR mortgage

Interest rate vs. APR mortgage

While both the interest rate and the APR provide effective benchmarks for you when comparing different loans, the chief difference between APR and interest rate is that the former incorporates all of the other fees that you are going to need to pay in order to secure a mortgage.

However, as interest rates are generally lower than APR, APR’s are generally advertised along when rate and terms are shown. Please note, generally APR may vary from loan to loan, depending on various factors.

What is the difference between APY and APR?

Another term that you may have seen is the APY, otherwise known as the Annual Percentage Yield. APY differs because it considers the compound interest, and can be viewed as the total cost of the loan. As a consequence, the APY of a loan is higher than the APR. The higher the interest rate is, and to a lesser degree the extent, the more diminutive the compounding periods, the larger the difference between the APY and the APR.

APR vs Daily Periodic Rate vs Nominal Interest Rate

APR is usually higher than the nominal interest rate on a loan. This is because the nominal rate of interest does not account for any other cost accrued by the borrower. The nominal rate is typically lower on your mortgage if you do not account for the origination fees, insurance, and closing expenses. If you end up rolling these into a home loan, your mortgage balance increases, as does your APR.

On the other hand, the daily periodic rate is the interest that is charged on the balance of the loan on a daily basis, i.e. the APR divided by 365. Credit card providers and lenders are allowed to represent APR on a monthly scale, though, as long as the full APR over the 12 months is listed somewhere on the agreement before it is signed.

The length of your loan makes a difference

It is also important to consider how long you intend to stay on your property and the length of your loan. A loan with the lowest APR means you are going to be paying the least to finance your property.

However, if you are not planning to stay in the property in question for long, you may want to consider choosing a higher APR but opting for a loan that has fewer upfront costs. This is because the total cost of the loan is going to be less over the first few years. By the time the costs rise, you will have looked to move on anyway.

As APR spreads the fees over the entirety of the loan, the value is only optimized if you intend to stay in the property for the duration of the mortgage, so you must consider this when searching.

Sources

https://www.consumerfinance.gov/ask-cfpb/what-is-the-difference-between-a-mortgage-interest-rate-and-an-apr-en-135/
https://www.bankrate.com/mortgages/apr-and-interest-rate/
https://www.nerdwallet.com/article/mortgages/apr-annual-percentage-rate
https://www.forbes.com/advisor/mortgages/apr-vs-interest-rate/