Rate vs. APR: what the gap actually tells you

What's the difference between the interest rate and the APR?

The interest rate is what the lender charges you to borrow, and it sets your monthly principal and interest payment. The APR is a broader number. It starts with the interest rate and adds the lender's fees, discount points and some other loan costs, spread over the life of the loan and shown as a yearly rate.

Because the APR includes those costs, it's almost always higher than the interest rate. Lenders that advertise a rate generally have to show the APR next to it for that reason.

What does the APR include?

The APR includes most of what you pay to get the loan itself: origination and underwriting fees, discount points, mortgage insurance, and prepaid interest.

It usually leaves out costs you'd pay no matter which lender you choose, like the appraisal, title insurance and recording fees. Your property taxes and homeowners insurance aren't in it either. So the APR isn't your total cost. It's a way to see what the lender is charging.

What does a big gap between the rate and the APR mean?

A big gap means a lot of cost is riding on top of the rate. Usually that's discount points, high lender fees, or both.

That's the most useful thing the APR does. A quote with a low rate and a much higher APR is telling you the low rate was bought with money at closing. A quote where the rate and APR sit close together has fewer lender charges. When one rate looks well below everyone else's, check the APR before anything else.

Is a lower APR always the better deal?

No. The APR assumes you keep the loan for its full term and spreads the upfront costs across all of it. Most people sell or refinance well before that.

If you pay points and refinance a few years later, you paid those costs for a rate you didn't keep long, and the APR made them look smaller than they were. For a loan you expect to keep only a short time, a quote with a slightly higher rate and fewer upfront costs can cost less, even with a higher APR. How long you'll keep the loan matters as much as either number.

Can you compare APRs on different kinds of loans?

Only on loans of the same type and term. Comparing a shorter-term loan's APR to a longer-term loan's, or a fixed rate to an adjustable rate, doesn't tell you much.

The APR on an adjustable-rate mortgage is especially rough. It assumes the rate adjusts based on today's market, but no one knows where rates will be when the fixed period ends.

Where do you find the APR on a Loan Estimate?

On page 3, under Comparisons. You'll also see the total interest percentage there, which shows how much interest you'd pay over the loan's full term compared with the amount you borrow.

Use the APR as a quick check, then go to page 2. The origination charges show exactly what the lender is charging and whether points are included. Closing costs walks through the rest of the Loan Estimate.

Quick answers

Why is the APR higher than the interest rate?

Because the APR adds the lender's fees, points and some other loan costs to the interest rate and spreads them over the life of the loan.

Should I compare mortgages by rate or APR?

Look at both. The rate sets your payment, and the APR shows the lender's costs. Also check the origination charges on each Loan Estimate.

What does it mean if the APR is much higher than the rate?

It usually means the quote includes discount points or high lender fees.

Is a lower APR always the cheaper loan?

Not always. The APR assumes you keep the loan for its full term. If you'll sell or refinance sooner, upfront costs matter more than the APR shows.