Many home buyers have heard both terms, yet few are aware that interest rates and APR correspond to two different home loan costs. Understanding the difference between interest rate and APR, or annual percentage rate saves home buyers thousands of dollars annually.
Metropolitan Mortgage Corporation is here to define both terms and help you decipher the best choices for your future.
The Difference Between Interest Rate and APR
Mistakenly used in tandem, interest rates and APR are actually two very different things that play a very important role in your mortgage.
Interest rates constitute the amount that homebuyers will end up paying for the loan, while APR compiles the true total cost of your home, including interest rate, closing costs, broker fees, discounts, and other additional factors.
Deciphering the difference between interest rate and APR help home buyers make informed mortgage decisions.
Let’s take it a step further and dig into what makes up interest rates, APR and how they will affect home buyer’s financial future.
What Is an Interest Rate?
Like any large purchase, buying a home is a large investment. A mortgage, however, allows you to take on such an endeavor.
Banks or mortgage professionals traditionally finance up to 80 percent of the price and you, the borrower, will pay that amount back with interest, over a predetermined period of time.
An interest rate is the cost that home buyers pay annually to borrow the mortgage amount. Presented as a percentage, the chosen rate can be fixed or variable.
As it alludes to, a fixed interest rate doesn’t change. The same cannot be said for variable mortgages, also known as an adjustable rate.
A variable rate waxes and wanes under certain conditions following a fixed-rate period.
For example, say you take out a 5/1 variable rate mortgage with a 30-year payment plan. The interest rate will have a five year fixed-rate period of 4 percent.
Following the fixed-rate period, the interest rate can fluctuate every subsequent year as long as it doesn’t hit its 12 percent cap. Many variable rate mortgages will have caps, or limitations, on how high or low the rate can adjust.
Pros and Cons of Fixed and Variable Interest Rates
Many home buyers choose variable rate mortgages because the initial payments are lower with a gradual increase following the fixed-rate period.
Fixed-rate mortgages are clear, concise, and constant. Homeowners with fixed-rate mortgages have the security of knowing that their payments won’t change.
That being said, monthly payments tend to be expensive. This usually sways borrowers towards variable rate mortgages.
Variable rate mortgages don’t come without their pitfalls as well.
Following the fixed-rate period, monthly payments will increase and the first one may be a shock. Many homeowners get very used to their modest monthly bill and are shocked when payments become a hefty burden on their finances.
Variable rate mortgages are also not as clear-cut as fixed-rate mortgages. Borrowers can easily become confused or worse, get trapped in a shady deal with an unprofessional organization.
It pays to plan with a professional! Find out what you can expect to pay by using our online Mortgage Calculator!
You can also check out the latest interest rates for Conventional, FHA, VA, USDA, and Jumbo mortgage loans here.
What Is an Annual Percentage Rate (APR)?
Interest rates are important, but the true scope of costs lie within the APR. An APR casts a wider net to measure the cost of your mortgage.
APRs reflect the interest rate as well as other monetary factors such as broker fees, closing costs, and discounts. This will also be presented as a percentage.
Imagine being able to cut out the minutiae and get to the bottom of what you’re really paying? The key difference between interest rate and APR is that APR expresses the true cost of your mortgage throughout its lifespan.
Pros and Cons of APR
The Federal Truth in Lending Act (TILA) of 1968 states that every consumer loan agreement must disclose the APR to give borrowers realistic cost projections.
Knowing the APR, home buyers can choose the right mortgage and rates to fit their budget.
APRs come with their own limitations, too. The first is the loan origination. Banks and mortgage professionals may calculate the APR differently, so there may be a discrepancy among percentages.
APRs also assume homeowners will hold the loan for its entire life-cycle. This hinders your ability to sell or refinance your home in the future.
Life happens. You may find yourself selling your home for a variety of reasons or due to unexpected life events. If you sell or refinance your home, expect to accrue additional costs.
Using Interest Rates and APR to Your Advantage
Now that you know the difference between interest rate and APR, you will be able to make a smarter financial decision. Home buyers that understand both rates will have a more accurate projection of their true total costs.
This can also help you make an informed financial decision. For example, if you plan to stay in your home for the foreseeable future, between 20-30 years, it would be beneficial to both you and your wallet to choose a loan with a low APR. This gives you plenty of time to pay your home off.
However, if you’re unsure how long you will stay in your home, it’s worth it to choose a higher rate and APR as the total cost will be less.
Using both percentages in tandem gives home buyers two distinct secret weapons. First, buyers will have a bird’s eye view of total cost projections, present, and future. That’s good news for planning.
Second, buyers will be able to align their future plans with their financial ones. For example, buyers will be able to compare interest rates and APR percentages to other loans. This means monthly payments that fit your budget, instead of choking it.
Mortgage Professionals You Can Trust
Since 1996, Metropolitan Mortgage has been helping homeowners in Kansas and Missouri purchase their dream homes. As a multi-year Five Star Award winner, families can have the peace of mind knowing they’re in good hands.
Check out our home loans and get started on your Pre-Approval application!