The Difference Between APR and Interest Rates

The Difference Between APR and Interest Rates

When you are going to take out a mortgage, the words Annual Percentage Rate (APR) and mortgage interest rates become very important. Due to how similar the titles are, you may be inclined to believe these terms are synonymous. However, in reality, an APR and a mortgage interest rate are very different. It is important to have all of the facts before you take out a mortgage, to determine which one is the best fit for you.

An APR usually encompasses the mortgage interest rate and other charges while a mortgage interest rate is just the yearly sum of money you pay in exchange for borrowing the lump sum without any other charges on it. There are many reasons why you may choose one over the other. Read below for more information on the differences between APR and interest rates to determine which one is best for you when considering a mortgage.

Annual Percentage Rates (APR)

An APR is a broader view of the money you are borrowing, providing a clearer picture of all the costs associated with the loan you take out. On average the APR are much higher than simple interest rates due to the range of costs of which it is comprised. Some of the costs involved in APR are:

  • Interest rates.
  • Points.
  • Fees.
  • Other associated charges for the loan.

Since many of these factors are based on lenders, the APR is determined by lenders and varies from one company to the next. The interest rates are the base costs for the loan you take out. Points, also known as discount points, allow you to lower your interest rates, provided you pay an upfront fee. The amount a loan is lowered depends on the current market, type of loan, and lender. The same APR loan may be offered for a lower rate at a different lender, which is why it is important to look at all available mortgages.

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If you take out an APR, there are two main types: fixed and variable. The fixed APR means the initial percentage of the APR will remain the same throughout the lifespan of the loan. A variable APR rises or lowers based on associated indexes. Depending on what your budget is like, one type may be preferable to the other.

How to Calculate Your APR

Calculating an APR can seem daunting at first but learning how to do it is useful when comparing the APR across multiple lenders. To calculate APR, the first step is to figure out what the monthly payments are going to be. Once you determine your monthly payments, you can take that number and multiply it with your amount financed, which is the amount of money a lender is willing to offer you. All of these calculations can be done in an excel sheet, which is recommended. Once you have the basic formula, you can calculate all of your prospective APR from different lenders to determine which rate is the best option.

Mortgage Interest Rates

Mortgage interest rates are the fees applied to the loan you take out, without any other fees added in. These rates are represented by percentages. Many different factors determine the percentage number on your interest rate. Those factors are:

  • Credit scores.
  • Location of your home.
  • The price of the home and the total loan amount.
  • Down payments.
  • Loan term.
  • Loan Type.
  • Interest rate type.

When lenders consider offering you a loan, credit scores are a large factor. Credit reports encompass credit history comprised of previous or current loans, all lines of credit, and payment history. Credit reports show how reliable you are with repaying the money you borrow. The higher your credit report score is, the lower your interest rates are, and you qualify for a higher loan sum.

Lenders base their rates on your home’s location. Interest rate tools are available to help you determine what the rates may be in the area in which you are looking to move. Home prices help determine the loan amount and rates as well. Often the loan amounts offered to you are calculated by the price of the home and closing costs with your down payment subtracted. Down payments are the amount of money you pay upfront on your home.  Most experts advise buyers to pay a 20 percent or higher down payment in order to get a lower interest rate.

Length of Loans Make a Difference

When you are looking at the terms of a loan, shorter-term loans have lower interest rates. However, lower loans come with higher monthly payments.

Evaluate the specifics to learn how much lower your interest will be versus how high the monthly payments are when determining the length of a loan.

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Interest rate types come in two varieties: adjustable and fixed. Fixed rates do not fluctuate over time like adjustable rates will. When you take out an adjustable rate loan, your initial interest rate may be lower but then increase as time continues. Many different types of loans, like conventional, FHA, VA, and USDA, exist.  The type of loan you choose affects the interest rate as well. Research all available types of loans you are eligible for and how those impact your rates with lenders before reaching a decision.

Comparing APR to Interest Rates

When comparing APR to simple mortgage interest rates consider the following factors. How long you plan to live in the home is important. For example, if you buy a home and after a few years decide to sell it, APR is not the best option. In this case, if you choose APR and pay discount points, then you have actually paid more money than you would have with a simple interest rate. APR is most effective when you plan to keep a loan for a long time period.

APR rates are not just for home loans, however. Credit cards also have them and depending on the card you have the APR rate changes depending on the type of transaction you perform. For example, some credit cards charge one APR rate for balance transfers, a different one for cash advances and another one for purchases. However, the way to control your APR on a credit card is to pay off the balance in full each month, if possible, effectively reducing your APR to 0 percent.

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By Admin