Understanding interest rate vs. APR

This is fairly straightforward: The interest rate is the annual cost associated with borrowing the money used to buy your home. Expressed as a percentage, it’s used to determine your monthly mortgage payment.

But the interest rate doesn’t include all the associated costs and fees you pay up front to obtain that mortgage – such as closing costs, discount points (sometimes paid to reduce the interest rate), loan origination fees and mortgage insurance.

That’s where the APR comes in. It’s intended to help you compare the different loan options from a lender or the different offers you receive from multiple lenders.

If all you really care about is finding the lowest monthly payment, focus on the interest rate, because it will determine what you owe each month.

If you’re convinced that you found your dream home and will be in it for decades to come, the APR will help you compare the true cost of borrowing the money to fulfill that dream.

But what if you’re somewhere in between, like many of us? Of course you care about the monthly payment – but you also want to know the total cost of borrowing that money. And you realize you may decide to move 5 to 10 years down the road.

In that scenario, comparing the APR on different loans can be helpful, though the lowest APR may not necessarily represent the lowest overall cost. Think of the APR as a guide, but discuss with your lender the fees and costs associated with their mortgage offer. Be sure to ask questions until you feel comfortable you understand the answers and are ready to make an informed decision.