APR vs interest rate — the difference that costs you
The interest rate is the cost of borrowing the principal. The APR (Annual Percentage Rate) includes the interest rate plus any upfront fees — origination fees, discount points, broker fees, application fees — expressed as an annualized rate. APR is always equal to or higher than the nominal interest rate.
Why APR matters when comparing loans
Two lenders offering the same 6.8% interest rate can have very different APRs once fees are factored in. Lender A charging $3,500 in fees on a $250,000 mortgage has a meaningfully higher APR than Lender B charging $1,200. By law, lenders must disclose APR — making it the single best number to compare loans.
APR limitations
APR assumes you'll hold the loan for its full term. If you sell the home or refinance within 5–7 years (as most Americans do), the upfront fees get spread over fewer years — making the effective cost higher than the APR suggests. For short holding periods, look at the lender's "Loan Estimate" form which shows the 5-year cost of borrowing.
For adjustable-rate mortgages (ARMs), APR is unreliable — it's calculated using the introductory rate, not the rate after the first adjustment.
Frequently asked questions
Why is my APR higher than my interest rate?
APR includes the interest rate PLUS upfront fees (origination fees, points, broker fees, application fees), expressed as an annualized rate. A 6.8% interest rate with $3,500 in fees on a $250,000 mortgage yields a meaningfully higher APR.
Is APR the same as APY?
No. APR (Annual Percentage Rate) is the cost of borrowing, excluding compounding. APY (Annual Percentage Yield) is the effective yield on savings or investments, INCLUDING compounding. A 12% APR loan with monthly compounding has an APY of 12.68%.
Does APR assume I'll hold the loan for the full term?
Yes. APR amortizes fees over the full loan term. If you sell or refinance early, the effective cost of fees is higher than the APR suggests. For short holding periods, look at the lender's '5-year cost' disclosure.
How do discount points work?
One point = 1% of the loan amount, paid upfront to reduce the interest rate (typically by 0.25%). On a $300,000 loan, one point costs $3,000 and might reduce the rate from 7.0% to 6.75%. Worth it if you'll keep the loan past the break-even point.
What is a 'no-closing-cost' mortgage?
There's no such thing — the costs are just hidden. 'No-closing-cost' mortgages either roll fees into the loan balance (increasing principal) or charge a higher interest rate (lender credit covers fees). Compare APRs to see the true cost.
Why don't all loans disclose APR?
In the US, the Truth in Lending Act requires APR disclosure for consumer loans (mortgages, auto, personal, credit cards). Business loans and some private loans aren't required to disclose APR — always calculate it yourself.
Is APR reliable for adjustable-rate mortgages (ARMs)?
No. APR for ARMs is calculated using the introductory rate, assuming it never changes. Since ARMs almost always adjust upward after the intro period, the APR understates the true cost. Use a worst-case scenario calculator instead.
Glossary of key terms
- Nominal Interest Rate
- The stated rate charged on the loan principal. Does not include fees.
- APR (Annual Percentage Rate)
- Interest rate plus most upfront fees, expressed as an annual rate. Required disclosure under Truth in Lending Act.
- APY (Annual Percentage Yield)
- Effective annual yield including compounding. Used for savings accounts and investments.
- Discount Points
- Upfront fee (1 point = 1% of loan) paid to reduce the interest rate. Worth it if you'll hold the loan long enough.
- Lender Credit
- When the lender gives you money toward closing costs in exchange for a higher interest rate. Effectively the opposite of paying points.
Common mistakes to avoid
- Comparing loans by interest rate instead of APR — fees can add 0.5-1.5% to the effective rate
- Assuming 'no closing costs' means free — they're just rolled into the rate or principal
- Forgetting that APR assumes full-term holding — early payoff makes fees costlier
- Trusting APR on ARMs — it understates the true cost of adjustable-rate mortgages
- Not asking for the Loan Estimate form, which shows 5-year cost (better for short holding periods)
Pro tips
- Always get a Loan Estimate (formerly Good Faith Estimate) from at least 3 lenders — the format makes apples-to-apples comparison easy.
- If you plan to sell or refinance within 7 years, prioritize low fees over low rate — points rarely pay back in that timeframe.
- If you plan to keep the loan 10+ years, paying points to reduce the rate often saves thousands.
- For ARMs, calculate worst-case scenario: rate adjusts to maximum cap at first opportunity — see if you can still afford the payment.
- Mortgage brokers can shop multiple lenders at once — but they're paid by lenders, so ask how they're compensated.
Results are estimates for educational purposes only and not financial advice. Consult a licensed professional for advice specific to your situation.