Interest Rate: The Cost of Borrowing, Simply Put
The interest rate is the cost you pay each year to borrow money, expressed as a percentage rate. It does not reflect fees or any other charges you may have to pay for the loan.
When you see a mortgage advertised with a low interest rate, that rate determines your monthly principal and interest payment. It is the base for calculating how much you'll pay in interest over the life of the loan.
Sources: Consumer Financial Protection Bureau
APR: A Broader Measure of Total Loan Cost
The annual percentage rate (APR) is a broader measure of the cost of borrowing money than the interest rate. It reflects the interest rate, any points, mortgage broker fees, and other charges that you pay to get the loan. Because it includes these extra costs, the APR is usually higher than the interest rate.
The APR is designed to give you a more complete picture of what a loan really costs, allowing you to compare offers from different lenders on a more equal basis.
- Includes interest rate
- Includes points and mortgage broker fees
- Includes other charges paid to get the loan
- Usually higher than the interest rate
Sources: Consumer Financial Protection Bureau
What Fees Does APR Include?
The APR is calculated as the interest rate plus any additional fees charged by the lender. This includes origination charges and other fees charged when the loan is made. Under the federal Truth in Lending Act (TILA), the APR measures the total cost of credit, including costs such as transaction charges or premiums for credit guarantee insurance.
Importantly, APR is not based on state law definitions of interest. It often includes charges, such as a commitment fee paid by the consumer, that state laws might not classify as interest. Conversely, an APR might not include a charge, such as a credit report fee in a real property transaction, which some state laws might view as interest for usury purposes.
Because fee inclusions can vary, you should always look at the detailed Loan Estimate to see exactly which costs are included in the APR.
- Origination charges
- Points
- Mortgage broker fees
- Transaction charges
- Premiums for credit guarantee insurance
- Commitment fees
Sources: Consumer Financial Protection Bureau
How to Calculate APR from Loan Fees
To calculate the APR, you combine the interest rate with the additional fees charged by the lender, such as origination charges, points, and other costs. The federal Truth in Lending Act (TILA) requires lenders to provide specific disclosures about important loan terms, including the APR, and it establishes rules for how the APR must be calculated.
A simplified way to think about it: the APR is the interest rate adjusted to include the effect of upfront fees spread over the loan term. Because the fees are added to the loan amount, the APR will be higher than the interest rate if fees are present.
The exact APR depends on the loan term and the timing of payments, but this illustrates the principle.
Sources: Consumer Financial Protection Bureau
Where to Find Interest Rate and APR on Your Loan Estimate
On the Loan Estimate, you can find both the interest rate and the APR. The interest rate is found on page 1 under 'Loan Terms,' while the APR is found on page 3 under 'Comparisons.'
These two figures serve different purposes: the interest rate tells you the base annual cost of borrowing, and the APR includes many fees to show the total cost. When comparing loan offers, look at the APR to understand the true cost of borrowing.
Sources: Consumer Financial Protection Bureau
Why APR Can Differ from the Advertised Interest Rate
Lenders may advertise a low interest rate to attract borrowers, but the APR can be higher because it includes fees. These fees can include origination charges, points, and other costs. Since different lenders may include different fees in their APR calculations, the APR can vary even when the interest rate is the same.
This is why it's important to compare APRs rather than just interest rates when shopping for a mortgage.
Sources: Consumer Financial Protection Bureau
How to Compare APR Across Different Lenders
When comparing loan offers, use the APR as a standardized measure. Because the APR is calculated according to federal rules, it provides a consistent way to evaluate the total cost of the loan, including fees.
However, keep in mind that fee inclusions can vary by loan type and lender practices. Be sure to review the Loan Estimate from each lender to see exactly what fees are included in the APR and how they affect your total costs.
- Request Loan Estimates from multiple lenders
- Compare APRs side by side
- Check which fees are included in each APR
- Consider both the interest rate and APR for a full picture
Sources: Consumer Financial Protection Bureau
Frequently asked questions
Why do ARMs have a different APR than fixed-rate loans?
Adjustable-rate mortgages (ARMs) may have a lower initial interest rate that can adjust later. The APR is calculated based on the initial interest rate and fees, so it may not reflect the total cost of the loan if the rate changes in the future. This can result in a different APR compared to a fixed-rate loan, but the exact calculation rules are governed by the federal Truth in Lending Act. Your lender will disclose the APR on the Loan Estimate, but be aware that for ARMs, the APR may not capture future rate adjustments.
Sources: Consumer Financial Protection BureauDo all lenders calculate APR the same way?
The federal Truth in Lending Act requires lenders to provide specific disclosures about the APR, and it sets rules for how the APR must be calculated. However, because the APR includes certain fees that can vary by loan type and lender practices, the final APR may differ from lender to lender even for the same interest rate. You can see the exact fees included in the APR on your Loan Estimate.
Sources: Consumer Financial Protection BureauHow does APR affect my monthly payment?
The APR does not directly determine your monthly payment. Your monthly payment is based on the interest rate, loan amount, and loan term. The APR is a broader measure that reflects the interest rate plus certain fees, giving you a way to compare total loan costs. A higher APR generally means more fees, but your monthly payment may be the same if the interest rate is the same.
Sources: Consumer Financial Protection BureauIs a lower APR always better?
A lower APR can indicate lower total borrowing costs, but it is not always the only factor to consider. You should also review the interest rate, loan terms, and the specific fees included in the APR. Sometimes a lower APR may come with a higher interest rate or less favorable terms. Always compare the full loan cost, not just the APR.
Sources: Consumer Financial Protection BureauSources
- What is the difference between a mortgage interest rate and an APR? — Consumer Financial Protection Bureau
- CFPB Laws and Regulations TILA — Consumer Financial Protection Bureau