Interest Rate – The rate of interest a bank will charge you on your mortgage every year. For instance on a $100 mortgage with a 7% interest rate, you would pay $7 interest in your first year.
APR – Stands for Annual Percentage Rate. APR includes your interest rate plus any fees or points the bank is charging you. This allows you to compare two loans fairly, and decide which one will cost you less. A lower APR means a loan is cheaper over the whole length of the mortgage, but may be more expensive for a shorter period.
To understand this short term vs long term trade off, use this calculator:
The above calculator compares the cost of paying fees vs a higher monthly payment. It also takes into account how much money you would earn if you put the difference in fees into an interest paying account at 2%.
Here is a summary of the differences between the APR and Interest Rate:
|Use alone to compare mortgages||No||Yes|
|Lower means better (full term)||Maybe||Yes|
|Lower means better (short period)||See Above Tool||Maybe|
One last point to consider, there are a few cases where you might not choose a loan with a lower APR:
- If you were sure you were moving quickly, then use the above calculator to see if it is worth paying extra fees to get a lower APR over the time period you are staying in the home.
- If you cannot afford to pay the fees involved in a lower APR loan, or need the money for other things.
If you want to understand the math behind APR, take a look at this wikipedia page.