Law & Legal

What is the Difference Between APR and Interest Rate?

What is the first thing you consider when shopping for a home loan in Dallas, Texas? 

If you answered the interest rate, you’re not alone. 

Just like anyone else, you want to grab the best mortgage deal with the least possible interest rate. But did you know the interest rate advertised by your mortgage company in Dallas isn’t the same as APR? 

What is the difference between these two terms? Why is it important to know about both interest rate and APR ahead of sealing a deal? 

We have created this post to highlight the differences between interest rates and Apra. Even if you have a clear understanding of how APRs work with credit cards and car financing, there’s still a lot you need to know about how they actually work with home financing. 

Interest Rate Explained

By definition, an interest rate is a cost you’ll have to pay against borrowing money. Interest rate is expressed as a percentage, and it is usually charged annually. 

APR Explained

APR stands for Annual Percentage Rate. It includes both a loan’s interest rate as well as financing charges. In simple words, the APR of a loan represents the total cost of credit, including interest rate, finance charges, and time. 

APR is also expressed as a percentage. Because APR involves other costs as well, it is usually higher than your interest rate. 

What fees are included in APR?

The mortgage APR generally involves these costs:

  • interest
  • points
  • origination fee
  • broker’s fee 
  • insurance fee

Besides that, an APR may also include prepaid interest, applicable loan fee, or other mortgage lender’s charges. 

According to Federal law, lenders are not required to include these costs into their APRs:

  • Title examination/insurance fees
  • Document preparation costs
  • Notary fees
  • Flood hazard/pest inspection fee
  • Attorney charges
  • Government-levied taxes (transfer charges+recording fees)

Wondering why these costs are not included in an APR? That is because they’re third-party costs, and the money you pay for them doesn’t go to your lender. 

Interest Rate vs. APR – What is the Difference

Ideally, your mortgage lender should showcase both interest and APR to give you a clear idea of the total cost of your credit. While APR is supposed to be higher than your interest rate in most cases, there are exceptions. 

For example, the interest rate and APR will be the same in case of no-closing cost financing. Similarly, the APR for adjustable-rate mortgages can be lower than the actual interest rates. This usually happens when there is an overall decline in the interest rate environment. 

But obviously, no one can predict how low your APR will be because it is practically impossible to predict what will happen to the interest rate over the term of your loan. 

Can You Use APR as a Comparison Tool?

Can you use APR to compare different mortgage offers?

Yes, you can. But it is not the best way. 

APR can be used more effectively as a regulatory tool to shield loan buyers against fraudulent or misleading advertising practices. 

Some acts and regulations require lenders to show an APR when they advertise their interest rates. That means when you visit the lender’s websites to analyze who might offer the best rate, it will be easier for you to tell whether the deal you’re about to make is worth all the money (interest+fees). 

While APRs appear to be a useful comparison tool, most borrowers don’t really use them to compare mortgage offers. That’s because most of them don’t get a single mortgage and hold it until it’s paid off. 

How are Interest Rates and APRs Determined and Calculated?

Well, it depends on the type of credit you’re applying for. When it comes to home loans, your lender may decide which interest or APR (variable or non-variable) to charge. They make their decision depending on what you have included in your loan application and your credit history. 

This goes without saying that the better your credit history, the lower your APR or interest rate might be. 

As far as the calculations are concerned, every lender uses its own formulas to figure out how much money you have to pay on the type of loan. 

Your lender will calculate the mortgage APRs by including discount points and other charges. 

Make sure you discuss interest/APR interest payment terms clearly with your lender before signing any contract.

Conclusion

Here’s a quick recap of what we have discussed so far. We talked about the interest rate and APR. Also, we highlighted what makes these two terms differ from each other. 

Besides that, we also talked about how you can determine and calculate interest rates and APRs on your loan/credit. 

Now that you know the difference between these two terms, we’re sure you can make a smart decision when applying for a home loan.

CAITIE C.

CAITIE C. is a digital marketing and SEO Expert working for multiple organizations to boost their business and online presence.

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