Understanding Mortgage APR vs Interest Rate
When comparing mortgage offers, the Annual Percentage Rate (APR) provides a more complete cost picture than the interest rate alone, yet many borrowers focus solely on interest rates and miss thousands in additional costs. The interest rate determines your monthly payment amount, while APR includes the interest rate plus closing costs, origination fees, points, and other financing charges spread over the loan term. Understanding the difference between rate and APR, how to compare offers using APR, and when lower rates with higher fees make sense empowers you to make truly informed financing decisions.
The gap between interest rate and APR reveals the cost of loan fees and closing costs. A "no-cost" refinance might advertise a 6.5% rate with 6.7% APR—the 0.2% difference represents fees built into the loan. A rate with upfront costs might show 6.0% rate with 6.15% APR, where you pay $5,000 in points and fees at closing. For a $300,000 loan, that 0.2% APR difference equals approximately $360 annually or $10,800 over 30 years—less than the $5,000 in upfront costs if you keep the loan the full term, but more expensive if you refinance or sell within 13-14 years. Higher rate/lower fee options favor shorter ownership periods, while paying points for lower rates benefits longer-term owners.
Discount points offer a direct trade-off between upfront costs and long-term interest savings. One point costs 1% of the loan amount ($3,000 on a $300,000 loan) and typically reduces your rate by 0.25%. Paying two points ($6,000) to reduce rate from 6.5% to 6.0% saves approximately $95 monthly ($1,140 annually), recovering the $6,000 cost in 5.3 years. If you keep the loan 15 years, you save $17,100 minus the $6,000 cost for net savings of $11,100. However, if you refinance or sell after 4 years, you've paid $6,000 to save only $4,560, losing $1,440. The break-even calculation—upfront cost divided by monthly savings—determines how long you must keep the loan to benefit from paying points.
APR comparisons work best when loans have identical terms and amounts. Comparing a 30-year loan to a 15-year loan using APR is misleading because loan term affects both payments and total interest dramatically independent of fees. Similarly, comparing $300,000 versus $320,000 loans distorts APR comparison because fixed fees represent different percentages of loan amounts—$3,000 in fees is 1% of $300,000 but only 0.94% of $320,000. For accurate comparison, get quotes for identical loan amounts and terms, then compare APRs to identify the true lowest-cost option. Some lenders advertise low rates to attract applications, then burden them with excessive fees—a 6.0% rate with 6.5% APR is worse than a 6.25% rate with 6.35% APR despite the lower advertised rate. The key is obtaining Loan Estimates from multiple lenders showing both rate and APR, using APR for apples-to-apples comparison, running break-even analysis if considering points, and considering your expected ownership duration—shorter timelines favor lower fees over lower rates, while longer ownership rewards paying points for rate reductions. Remember that shopping multiple lenders within 14-45 days counts as a single credit inquiry, minimizing credit score impact while maximizing your negotiating power for best terms.