APR vs Interest Rate - Whats the Difference?

Posted by Mike & Michelle Grizzell on Thursday, May 11th, 2017 at 5:17pm.

If you’ve been shopping for a mortgage for buying a home in Tampa this year, you’ve likely run across interest rates and APRs that have your head spinning. To you they may both seem like the same concept, a percentage of the home value that you pay your lender in interest for letting you borrow the money for it.

If that is the case, what is the difference between these two real estate terms? It comes down to the interest rate being your starting point while your APR is the associated fees of the mortgage loan tacked on. Take a closer look at these two terms so that you can understand the difference when it’s time to work with a lender on your next home in Tampa.

Understanding interest rates

The interest rate is likely what you imagine when it comes to your mortgage and what you’ll owe your lender. The amount of money you borrow has an interest rate which is the percentage that the borrower will recover from you during the life of the loan. This is a base fee or starting point in what you’ll pay for the mortgage loan, and getting the lowest interest rate possible will make a huge difference in your monthly payments.

Understanding Annual Percentage Rates

The confusion often comes in for home buyers when the APR is mentioned. The APR or annual percentage rate, refers to the calculated rate of the interest rate plus lender fees required to finance the mortgage. The APR is there to help the borrower understand the tradeoff between the fees paid at closing and the interest rate.

Legally banks are required to show the APR next to the interest rate as a part of the Truth in Lending Act. The fees paid at closing may include paying higher fees to lower interest rates or the increased interest rate which covers closing costs.

How do they come up with the APR?

The APR is calculated by incorporating the lender fees into the interest rate. The lender will amortize the fees over the life of the loan treating them like additional payments, and then calculating a new rate before the fees are added to the original loan amount.

If you were borrowing $200k and the total was $3k, your loan amount would actually be $203,000. Then an interest rate would be added to calculate the monthly payment. The APR would be calculated by looking at what the rate would have been for a loan with the new monthly payment and the original loan.

If your interest rate was 5% causing monthly payments at $1,089.75, then by taking this monthly payment and the original loan at $200k, you can figure the APR is 5.13%; traditionally higher than the interest rate to include the fees.

The issue to keep in mind with the APR is that it takes the fees paid upfront and spreads them over the life of the loan making it accurate only in the event that you were to keep the mortgage the entire length of it. Most borrowers don’t keep it because they end up moving or refinancing. You also could be dealing with different fees for different lenders when the APR is calculated.

Make sure you understand the difference between interest rates and APRs when you are looking around for a mortgage this year. It could make a big difference in your payments each month and over the life of the loan.

 

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