When shopping for a loan, you'll encounter both "interest rate" and "APR." These terms are related but represent different things—and understanding the difference can save you thousands.
Interest Rate: The Cost of Borrowing
Your interest rate is simply the cost of borrowing the principal amount, expressed as a percentage. It's the rate used to calculate your monthly payment.
For a $200,000 mortgage at 7% interest:
- Monthly payment calculation uses the 7% rate
- Your monthly principal & interest = $1,331
- 7% is what you'll see advertised
APR: The True Cost of the Loan
APR (Annual Percentage Rate) includes the interest rate plus other costs associated with borrowing:
- Origination fees
- Discount points
- PMI (if applicable)
- Prepaid interest
- Other lender fees
Key Difference: APR will always be higher than or equal to the interest rate when fees are included. A mortgage advertised as "7% APR 7.125%" means the rate is 7.125% but the APR with fees is 7%.
Why This Matters
Let's compare two $200,000 mortgages:
| Loan | Interest Rate | APR | Fees |
|---|---|---|---|
| Lender A | 7.0% | 7.3% | $12,000 |
| Lender B | 7.25% | 7.4% | $5,000 |
Even though Lender A has a lower interest rate, Lender B's lower fees result in a lower APR—and is actually the cheaper option.
Key Takeaways
- Compare APR, not interest rates, when shopping for loans
- APR gives the true cost including all fees
- Lower APR = cheaper loan over time
- APR is required to be disclosed for most loans
- Interest rate matters for your monthly payment calculation