Mortgages are complicated, and they bring lots of complicated terms and definitions. APR? Interest Rate? What do they mean, and what’s the difference? Most importantly, what do they mean to your mortgage? And what can not knowing cost you? Let’s have a look.

Interest Rate

The principal is the amount of money you borrow. The interest rate is how much you pay each year to your lender to borrow that money. This is expressed as a percentage of the loan amount. The interest rate is one part of the APR.

When you repay a loan, you are repaying the principal, plus any interest accrued. Your monthly payment includes both principal and interest. Because of interest, you will end up paying more than the amount of your loan. How much more depends, in part, on the interest rate.

The interest rate on any given loan depends on a number of things. Borrowers with high credit scores often qualify for a lower interest rate. The amount of money you borrow may affect the interest rate. The length of your loan may also affect it. Sometimes borrowers can exchange a higher interest rate for a discount on closing costs.

If you want to calculate your monthly payments on a particular mortgage or loan, there are many online mortgage calculators you can use. Some calculate only for interest rate, while others figure in APR as well.  Here are a few:

APR: the Annual Percentage Rate

The annual percentage rate (APR) is the measure of the total cost of a loan. The APR consists of the interest rate plus the following additional charges:

Points, also called discount points, lower your interest rate in exchange paying an up front fee. In exchange for paying more up front, you will pay less every month. Points can be a good choice for someone who knows they will keep paying the loan for a long time. A lower interest rate will mean you will pay less money each month and over time.  

Each point is equal to one percent of the loan amount. For a $100,000 loan with two points, the buyer will pay an additional $2,000 at closing. Each lender has their own pricing structure, so a zero-points mortgage with one lender will not necessarily have a higher interest rate than a one-point mortgage with another. It’s important to do your research to find the best mortgage with the best APR.

Fees are another part of the annual percentage rate (APR). Different loans can come with different kinds of fees. Some of these fees include charges for different services, for example: mortgage broker fees and administration (paperwork) fees. There may be fees for different kinds of insurance or for applying for a loan. Mortgage Coach has a list of different fees that are often considered part of the APR.

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Not Understanding APR Can Cost You Money!

When trying to decide on a mortgage, make sure you understand the terms of the different loans you’re considering. Little differences can cost you a lot of money.

Be careful when comparing the APRs of adjustable rate mortgages. The interest rate of an adjustable rate mortgage follows a market index, so it will vary from month to month. The APR of an adjustable rate mortgage doesn’t reflect the maximum interest rate of the loan, so you may end up paying more than you think!

Be careful when comparing the APR of a fixed rate loan with the APR of an adjustable rate loan. The APR of the fixed rate loan may appear higher, but it will stay stable. The APR of an adjustable rate loan may be more or less, depending on the market.

Don’t look at only the APR when you’re trying to find the right loan for you. This explanation from the Consumer Financial Protection Bureau can help you to understand the terms of any loans you’re considering. You can use to tool to check your understanding of the loan terms. You can also make sure that the lender has explained the terms correctly. The CFPB also recommends getting multiple loan estimates from different lenders. That way you can find the one that works best for you.

Mortgages are complicated, but thousands of people get mortgages every day, and so can you. It’s important to know what you’re getting into and to have a realistic understanding of what you can handle. MortgageCalculator.org’s glossary of mortgage terminology is a good place to start. With a little reading and a little research, you can find the best product for your situation.

Featured image: CC by CC 2.0, by woodleywonderworks, via Flickr