What is the difference between the interest rate and APR on loans

When you compare mortgage offers, you’ll usually see two different rates listed.

APR (annual percentage rate) reflects the total cost of borrowing, while the interest rate reflects only the cost of the loan’s principal. That’s why APR is usually higher — it includes lender fees and certain closing costs rolled into the loan.

However, a higher APR doesn’t always mean you’ll pay more overall. How long you keep the loan, how much you pay upfront, and whether you refinance later all affect your true cost. Understanding how APR works helps you compare loan offers more accurately and choose the one that fits your plans.

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What is an interest rate?

As most loan shoppers and homeowners know, a loan’s interest rate shows how much money the lender charges for borrowing money. Yes, you’ll need to repay the loan’s principal, which is the amount borrowed, but you’ll also pay more.

The loan’s interest rate shows how much more. It’s easier to see how interest works when you’re dealing with smaller numbers. So let’s say you borrowed $1,200 from a friend, and you agreed to pay back this personal loan a year later.

You and your friend agree on 5 percent interest. This adds another $60 to the $1,200 debt. Now, instead of repaying $1,200, you’re repaying $1,260.

That’s, more or less, how simple interest works. Mortgage loans, of course, are much bigger and more complex. They calculate compounding interest, which means the amount of interest paid each year changes, depending on the loan balance. Use Better's amortization calculator to see what this looks like on a fixed-rate loan.

What is an APR?

APR stands for annual percentage rate. It reflects the total cost of borrowing money, including the interest rate along with other fees, such as mortgage insurance premiums, cash paid to lower an interest rate (otherwise known as points), and several other lender fees.

By disclosing the loan’s APR, the lender is showing all borrowing costs, and not just the loan’s interest rate.

Let’s return to our example from above, the $1,200 loan from a friend on which you’ve agreed to pay 5 percent interest, which amounts to $60 a year. But what if you also agree to use a popular money transfer app to repay the debt, and the app charges 1.5 percent to complete the transfer?

You’re now paying a total of 6.5 percent – the original 5 percent interest plus the 1.5 percent app fee. Your APR on this loan would be the higher number, 6.5 percent.

Mortgage and refinance loans shouldn’t require charge transfer fees, but they may charge upfront loan origination fees, ongoing mortgage insurance premiums, and discount points. The loan’s APR reflects these charges along with the loan’s interest rate.

How is APR calculated?

The loan’s interest rate will typically make up the vast majority of APR. Along with the interest rate, APR can also include:

Mortgage insurance

Whether you’re getting a private mortgage insurance policy (PMI) on a conventional loan, or government-issued coverage on an FHA or USDA loan, mortgage insurance can be a big contributor to APR. A typical 30-year FHA loan charges 0.55 in annual insurance, for example. PMI on a conventional mortgage could add anywhere from 0.5 to 1.5 percent a year to the APR, at least for a while.

Most borrowers like to avoid mortgage insurance when they can, but this coverage may actually be a good investment. By protecting the lender from losing money on the loan, the coverage can help the lender lower interest rates which can create a net decrease in APR.

For instance, if PMI adds 1 percent to APR but allows the lender to lower its interest rate by 2 percent, PMI creates a win for the borrower.

Discount points

Some homebuyers pay cash upfront to lower their loan’s interest rate, and exchanging upfront cash for a lower rate can be a good tradeoff. For instance, paying $7,000 in points on a $350,000 loan might lower a loan’s interest rate by 0.5 percent while adding about 0.2 percent in new APR charges. That would create a net reduction in APR of about 0.3 percent.

But savings from points aren’t guaranteed, so borrowers should proceed carefully. Since the discount points are paid upfront, and their savings unfold slowly over the life of the loan, the borrower would need to keep the loan long enough to realize these savings. Selling the home, or refinancing, within the first few years of the loan’s term could short circuit the savings from discount points.

Some lender fees

APR also includes one-time lender fees, such as the loan origination fee, underwriting fee, processing fee, prepaid interest charges, and so on. These fees are part of a loan’s closing costs. Though paid upfront, APR spreads these fees across the loan term, which is 30 years for most homeowners, especially first-time buyers. Lender fees of, say, $5,000 on a $350,000 loan could add about 0.135% to the APR for a 30-year loan.

Keep in mind, not all closing costs will be included in APR. Home appraisal or title insurance fees, for instance, will not be calculated into APR. These fees may pass through the lender to the borrower, but they’re charged by third parties.

Some modern lenders are changing how they structure loan fees. For example, Better Mortgage’s streamlined process uses technology to cut costs so they can pass the savings onto you, which can close the gap between the interest rate and APR.

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Why do APRs and interest rates matter?

APR includes the loan’s interest rate, and it also adds in fees required to get the loan, so it reflects the total cost of the mortgage. Loan shoppers should compare a loan offer’s APR, as well as its interest rate, when shopping for loans.

These two example loan offers, both for 30-year loans of $350,000, show why:

**All numbers for example purposes only. Real rates and fees vary by borrower.

Lender 2 in this example offers the lower interest rate. When comparing only the loan’s interest rate, Lender 2 is the clear winner. But, to get that lower rate, Lender 2 is adding in more discount points, raising the APR. Comparing APRs would reveal this upcharge, making Lender 1 the winner.

So which loan is better? Does the lower APR make Lender 1 the best deal? That answer depends on how long you keep the loan. Despite its higher APR, Lender 2 may save more money if the borrower keeps the loan long enough for the lower interest rate to pay off.

How time affects APR and interest

Time factors into APR, so comparing APR can get confusing when different loans have different loan terms.

If you’re comparing loans with different terms, keep in mind the same cost will translate into a higher APR on shorter loan terms. For example, $5,000 in lender fees would add about 0.135 percent to the APR of a 30-year loan. That same $5,000 in lender fees on a 15-year loan would add 0.225% to the APR.

So, a higher APR doesn’t necessarily mean the shorter term costs more. It just means the same costs have been compacted into a smaller amount of time. In fact, shorter terms tend to save borrowers money in interest.

It’s simplest to compare APR on loans with the same term. When comparing loans that have different terms, be sure to check fee amounts on the Loan Estimate.

How variable rates and early payoffs affect APR

APR gives loan shoppers a fast way to compare costs on similar mortgages, but APR can’t anticipate all future costs of the loan.

For example, with an adjustable-rate mortgage, or ARM, the disclosed APR will show only costs connected with the loan’s introductory interest rate. After the intro rate expires, the interest rate – and along with it, the APR – could increase or decrease, depending on market conditions. Intro rates on an ARM typically last three to 10 years.

If you’re considering an ARM, be sure to compare APRs on ARMs with the same introductory rate.

Refinancing can also change the real costs of a loan that are reflected in APR. Paying off a mortgage early typically saves on borrowing costs by giving the loan less time to accrue interest.

Does APR or interest rate affect monthly payments?

The loan’s interest rate has a more direct impact on the loan’s monthly payment amount. Some of the costs that go into APR, such as upfront fees, get paid all at once, at closing. They don’t increase monthly payments.

The loan’s interest rate, on the other hand, is an ongoing charge which impacts the size of each monthly payment. That’s why paying upfront discount points, increasing the loan’s APR, can create savings.

Paying, for example, $7,000 in discount points to lower a rate from 6.5 percent to 6 percent could save about $40,000 over the life of a 30-year loan of $350,000.

But these savings build slowly, at about $112 a month. To get back the $7,000 spent in points, the borrower would need to keep the loan and make all its payments for about five years. After the five-year mark, the savings would continue to grow each month.

This break-even point on your loan depends on a lot of variables. A mortgage loan calculator can help you see your costs.

APR vs interest rates FAQs

How can you use APR and interest rates to help you choose a loan?

Since APR estimates the total cost of borrowing, comparing APRs between different lenders is a good way to compare loan costs, especially when all loans in the comparison offer the same loan term. Borrowers should also compare interest rates and monthly payment amounts. All of these numbers matter.

Why is APR higher than interest?

APR is usually higher than interest because it includes lender fees, discount points, and mortgage insurance premiums along with the interest rate. The interest rate alone doesn’t include upfront fees and annual premiums.

What is a good APR on a loan?

APRs vary a lot based on the borrower’s loan type, credit score, and current market conditions. Borrowers with strong credit scores, large down payments, and low monthly debt loads tend to qualify for lower interest rates and APRs. See today’s rates for more pricing context.

Is APR interest?

No. APR includes the interest rate but it also adds in other borrowing costs, like upfront fees and mortgage insurance premiums.

Compare all the numbers with a preapproval. Knowing the difference between a loan’s interest rate and its APR is a pro skill for loan shoppers.

APR is a more inclusive tool for comparing loan offers, but the loan’s interest rate matters, too, especially for borrowers who plan to stay in the loan for a decade or longer.

To see how your personal finances come together to create your interest rate and APR, start with a preapproval.

Better’s preapproval can show your custom rates in as little as three minutes without hurting your credit score since it relies on a soft pull.

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