Difference Between Mortgage Loan Rate and APR?

I’m starting to pay attention to mortgage loan advertisements now. Most of them include both a Rate and and APR. But what’s the difference?

The mortgage rate is the amount of actual interest charged. It’s usually a round number like 5.75% or 6.0%. So if you have a loan amount of $200,000 and a rate of 5%, you would be charged $10,000 of interest the first year. But the cost of a mortgage involves a lot more than just the rate. There are origination fees, loan discount points, private mortgage insurance, etc.

The mortgage APR, or annual percentage rate, includes both the interest and certain other loan fees. Although it was designed to make it easier to compare different mortgages offered by different lenders, it really doesn’t. First of all, there is no steadfast definition of APR ? each lender can calculate it differently. Some may leave out many fees to make their APR look more appealing, while others include everything. For example, they may assume you have a 20% down payment and won’t pay PMI.

In addition, the APR also has to make some common assumptions that may skew things. It almost always assumes a certain loan amount and that you will be holding the loan for the entire term of 30 years or more. If some of the costs are heavily front-loaded and you only keep the house for 5 years, your actual APR would be very different. The APR for adjustable rate mortgages (ARMs) are based on the future index rates being the same as they are now, which are still near historically lows.

In the end, it seems that both are useful to note, but neither should be used alone to compare mortgage loan offers.

Comments

  1. Just wanted to add, isn’t there also the difference similar to the difference between rate and APY for savings accounts (etc.)? Basically, APY/APR sort of estimates the compounding component that a normal rate causes over the course of a year?

  2. Jonathan, I have a question regarding the difference between auto loan and mortgage loan. Supposedly, if you pay extra on your auto loan, it will not have any benefits in terms of savings on interests over time as it is simple component interests. Is that true?

  3. SavingEverything says:

    Hey Jonathan, are you sure about this? For example, i researched the big banks (ie. WaMu, BoA, Wachovia,) and they all show the rate, the APY, and never have included any fees in calculating their apr/apy’s. Yes, the apr/apy shown assumes 20%down, no pmi. Any of the HUD or fees for loan are separate.

  4. Miller – Actually, there is a separate APY for mortgages too that takes into account the compounding of interest. You rarely see it though as APR is lower.

    big – It *may* be possible to put extra payments towards principal on your car loan, it just depends on how the loan interest is calculated an if there are prepayment penalties.

    Saving – Not ALL fees are included, that’s the whole reason why APRs aren’t perfect for comparison. APR always includes things like origination fees and discount points. APR usually doesn’t include things like appraisal fees, title fees, document fees, and so on. The reasoning is that these are expected to be constant for all loans, even though in reality they can vary.

  5. 10k in interest for the first year?! …that doesnt make much sense… add that to the actual payment you’ll be wiped out before you know it…

  6. actually, never mind that above comment, i dont know what im talking about…. and im also a renter ;)

  7. I recently saw the Pentagon federal credit union (penfed.org) advertise a 5/5 conforming ARM with an APR of 4.511 with a rate of 5.75. How can this be?

  8. Lorraine Pollard says:

    Good info I will pass on to my son who is the military and also just got into the real estate business. He is new into the business and I know the info and questions and comments that others make would be helpful to him.

  9. “So if you have a loan amount of $200,000 and a rate of 5%, you would be charged $10,000 of interest the first year.”

    Hi John great blog, but this comment is not exactly right. A loan of $200,000 at 5% would result in $9,932.99 of interest in the first year. In the 30th year of the loan interest would be $342.25. The total interest for any given year of the loan differs based on how far along you are. (Farthur along = Less interest = More principle) You just need to look at an amortization table for details.

    (P.S. Not trying to insult your intelligence, just pointing that out for readers new to this stuff.)

  10. Yes, you are right, because you will have paid down the principal a bit during the first year. Of course, the difference is very small. I am finishing up my first year of a 30 year mortgage, and I wish the principal paydown was greater. :)

  11. you can pay one extra pmt. at then end of every year towards principle and see how much difference it makes. It actually cuts your loan to 23 years than 30

  12. Rob P. says:

    So, we found the property and the seller’s have accepted our offer. Now, we just have to get a mortgage. We have exactly 20% to put down and have a great to excellent credit rating. So, I’m not concerned about getting the funds, however I am looking to keep the monthly cost as “low” as possible. What is the best to proceed? Should we go through a mortgage broker (what extra costs are associated) or should I just shop the local banks or would it be better to work with a national bank? Any help would be appreciated!

  13. I know this Post is old but for future readers the answer to Robs question above is that Mortgage Brokers can be just as competitive with the local banks. Shop a few of them and go with what you feel is best for you.

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