What is APR? APR vs Interest Rate Explained

APR vs Interest Rate: The Key Difference

The interest rate is the percentage charged on your loan principal. It determines your monthly payment. The APR (Annual Percentage Rate) includes the interest rate PLUS all loan fees and costs, expressed as a yearly rate. APR is always higher than the interest rate and reveals the true cost of borrowing.

Real Example

Lender A

Interest Rate: 6.00%

Fees: $6,000

APR: 6.25%

Monthly payment: $1,799 on $300K loan

Lender B (Better Deal)

Interest Rate: 6.125%

Fees: $2,500

APR: 6.20%

Monthly payment: $1,821 on $300K loan

Winner: Lender B. Despite higher interest rate, lower APR means lower total cost. You pay $22/mo more but save $3,500 in fees upfront.

What APR Includes (and Doesn't)

✓ Included in APR

• Origination fees (0.5-1% of loan)
• Discount points (if paid)
• Broker fees
• Underwriting fees
• Processing fees
• Loan application fees
• Prepaid interest
• Private mortgage insurance (PMI)

✗ NOT Included in APR

• Appraisal fees ($400-600)
• Home inspection ($300-500)
• Title insurance ($800-2000)
• Attorney/escrow fees
• Property taxes (prepaid)
• Homeowners insurance (prepaid)
• HOA transfer fees
• Credit report fees

How APR is Calculated

APR calculation spreads all loan fees over the life of the loan, then expresses them as a yearly percentage rate. Here's a step-by-step example:

Example: $400,000 Loan at 6.25% Rate

Loan Amount$400,000

Interest Rate6.25%

Origination Fee (1%)$4,000

Discount Points (0.5%)$2,000

Other Lender Fees$1,500

Total Fees$7,500

Resulting APR6.34%

The $7,500 in fees is factored into the loan's cost, spreading it over 30 years. This increases the effective annual rate from 6.25% to 6.34%. The difference (0.09%) represents the annualized cost of fees.

When APR Misleads

While APR is valuable for comparison, it has limitations:

1. Short-Term Ownership

APR assumes you keep the loan 30 years. If you sell or refinance in 5 years, the upfront fees have less time to amortize, making high-fee/low-rate loans worse deals than APR suggests.

2. ARM Loans

APR on adjustable-rate mortgages assumes current index rates continue, which is often inaccurate. A 5/1 ARM's APR doesn't reflect potential future rate increases.

3. Discount Points

Paying points lowers rate but raises APR in short term. If you paid 2 points ($8,000) to get 5.75% instead of 6.25%, APR might be 6.10%—higher than no-points 6.00% rate with 6.05% APR.

How to Use APR When Shopping

The Right Way to Compare

1
Get quotes on same day - Rates change daily, so compare quotes obtained within hours of each other
2
Compare APR, not just rate - 6.00% rate with 6.30% APR costs more than 6.125% rate with 6.20% APR
3
Consider your timeline - If keeping loan 7+ years, APR is accurate. If selling in 3-5 years, factor in early payoff
4
Ask for fee breakdown - Request itemized list of what's included in APR to spot junk fees
5
Calculate break-even - If paying points, determine how long to recoup cost via lower payment

Real Bergen County Examples

Scenario 1: First-Time Buyer ($500,000 Purchase)

Quote A

Rate: 6.25%

APR: 6.48%

$5,200 fees

Quote B

Rate: 6.375%

APR: 6.45%

$3,800 fees

Quote C (Best)

Rate: 6.50%

APR: 6.42%

$2,100 fees

Winner: Quote C. Highest rate but lowest APR. Saves $3,100 in fees, costs only $65/mo more than Quote A.

Scenario 2: Refinance ($600,000 Loan)

No Points

Rate: 6.00%

APR: 6.08%

Payment: $3,597/mo

Pay 1 Point ($6,000)

Rate: 5.75%

APR: 5.88%

Payment: $3,501/mo

Analysis: Paying point saves $96/mo. Breaks even in 62 months (5.2 years). Choose if keeping loan 6+ years.

What is APR?