If you’re applying for any type of loan, the first thing you’ll probably look at is the interest rate. Further down the application, you’ll also see a term called an APR (annual percentage rate). These two numbers may be similar, but the truth is that they’re different in subtle ways. By understanding the difference between these two terms, you can have a better insight on how much you’re really paying for a loan.
APR vs Interest Rate on a Home Loan
An interest rate is the nominal cost of borrowing money. When you receive a quote from a mortgage broker for a home loan (or refinance), you will be quoted based on the interest rate. The interest rate is what effects the actual payment amount of your loan. The APR can be found on the TIL (truth-in-lending) statement which will take into account all the other fees associated with your mortgage application. These include origination points charged by the broker, closing costs, broker fees, and even title fees.
If you’re comparing different mortgage lenders, the number you should look at is the APR. Looking at the APR will give you a holistic view of the true cost of the loan. However, you’ll need to be a little more cautious if you’re applying for an adjustable rate mortgage since it doesn’t take into account any future changes.
APR vs Interest Rate with Credit Cards
It’s also important to understand what an APR is when it comes to your credit card interest rate. The APR is the interest rate you are charged on an annual basis. However, the APR does not take into account for what happens when interest is compounded on a monthly or daily basis.
As discussed above, if you’re shopping for a mortgage, it’s best to look at the APR. On the other hand, credit cards should be looked at differently. There’s a term called annual percentage yield (APY) that actually takes into account any compounding interest. When you’re looking at the fine print on a credit card offer, make sure you look for the APY since the APR is the number that creditors like to emphasize.
Limitations on APR
Now that we know that the APR encompasses all the fees that go into a loan, one limitation on your APR is the unknown variable of how long you plan to keep the loan for. For example, if you’re comparing two mortgages but you only plan to stay in your home for 3-4 years, a lower APR might be more expensive. This is because you’re paying more in upfront fees whereas the higher interest rate loan will have less.
When comparing two different loans side by side, there are many factors to look into. The APR will give you a holistic view of the cost of the loan whereas the interest rate will reflect the actual monthly payment. Always consider the not so obvious factors such as how long you plan on keeping the loan since this can influence your decision.