Every mortgage quote comes with two percentages that look almost the same: an interest rate of, say, 6.5%, and an APR of 6.695%. They measure different things. The interest rate sets your monthly payment. The APR folds the cost of getting the loan into a single yearly rate, so you can compare offers that charge different fees.
Here's what goes into each number, how the APR is worked out, and the situations where the lower APR is not the cheaper loan.
Note: the figures in this article are estimates for illustration, not financial advice. Your lender's numbers can differ because of fees, escrow, rounding and loan terms. Check your Loan Estimate or ask your lender before making decisions.
The short version
- Interest rate: the yearly cost of borrowing the principal, as a percentage. It's what the lender uses to calculate your payment.
- APR (annual percentage rate): a broader yearly rate that also counts points, loan fees and certain other charges you pay to get the loan.
- When a loan has fees, the APR is higher than the interest rate. The bigger the gap, the more you're paying up front.
The Consumer Financial Protection Bureau puts it the same way in its explainer on the difference between a mortgage interest rate and an APR: the APR is "a broader measure of the cost of borrowing money than the interest rate."
What the interest rate measures
The interest rate applies to the balance you owe. On a fixed-rate mortgage, a 6.5% rate means each month's interest is the balance times 6.5% ÷ 12. Your payment is set so that, at that rate, the loan is paid off exactly at the end of the term.
For a $300,000, 30-year loan at 6.5%, that payment is $1,896.20 for principal and interest. Over 360 payments you'd pay $382,636.71 in interest. You can reproduce both numbers in our Loan Calculator, and How Loan Amortization Works walks through how each payment splits between interest and principal.
The rate says nothing about what it cost to get the loan. Two lenders can both offer 6.5% while one charges $1,000 in fees and the other $8,000.
What the APR adds
The APR is defined by the federal Truth in Lending Act and its rules, Regulation Z. It's built from the finance charge, which Regulation Z defines as "the cost of consumer credit as a dollar amount." That includes interest, plus charges you pay as a condition of getting the loan. Section 1026.4 lists the examples.
Usually included
- Interest
- Points (discount points you pay to lower the rate)
- Loan origination and underwriting fees, and similar lender charges
- Mortgage broker fees
- Mortgage insurance premiums that protect the lender if you default
Usually left out on a home loan
For loans secured by real estate, section 1026.4(c)(7) excludes certain fees as long as they're bona fide and reasonable:
- Title examination, title insurance and property survey fees
- Fees for preparing deeds, mortgages and settlement documents
- Notary and credit report fees
- Appraisal and inspection fees for services performed before closing
- Amounts paid into escrow, such as property taxes and homeowners insurance
So the APR isn't the total cost of closing. It's a rate that captures the lender-side costs of the credit. Your Loan Estimate lists every closing cost separately on page 2.
A worked example
Take the same $300,000, 30-year loan at 6.5%, and say the lender charges one point ($3,000) plus a $3,000 origination fee. That's $6,000 in prepaid finance charges.
The APR calculation treats those fees as money you never really received. You still owe $300,000 and still pay $1,896.20 a month, but the amount financed is effectively $300,000 − $6,000 = $294,000. The APR is the yearly rate at which 360 payments of $1,896.20 exactly pay back $294,000.
| Value | |
|---|---|
| Loan amount | $300,000 |
| Interest rate | 6.5% |
| Monthly payment (principal and interest) | $1,896.20 |
| Prepaid finance charges | $6,000 |
| Amount financed | $294,000 |
| APR | 6.695% |
There's no closed-form formula for that last step. The rate has to be found by trial: guess a rate, discount all the payments at it, compare the total with $294,000, adjust, and repeat until they match. Regulation Z's section 1026.22 says the APR must be calculated by the actuarial method (explained in its Appendix J) or the United States Rule method. For a regular loan, a disclosed APR counts as accurate if it's within 1/8 of 1 percentage point of the true figure.
A useful way to read the result: the $6,000 in fees costs about as much, over 30 years, as another 0.195 percentage points of interest.
Comparing two offers
This is the job the APR was made for. Say two lenders quote the same $300,000, 30-year loan:
| Offer A | Offer B | |
|---|---|---|
| Interest rate | 6.25% | 6.75% |
| Points and lender fees | $6,000 | $1,000 |
| Monthly payment | $1,847.15 | $1,945.79 |
| APR | 6.442% | 6.783% |
| Interest over 30 years | $364,975.80 | $400,489.69 |
Offer A has the lower APR. If you keep the loan for all 30 years, it's clearly cheaper: lower payments and about $35,500 less interest, which easily covers the extra $5,000 in fees.
But most people don't keep a mortgage for 30 years
The APR assumes you make every payment for the full term. If you sell or refinance early, the upfront fees have fewer years to pay for themselves.
Count the cost as fees plus interest paid so far (the principal you've repaid is yours either way). Offer A starts $5,000 behind and gains back a little each month. Using the same amortization schedule as the calculator, it catches up in month 40, a little over three years in. Before that, Offer B is cheaper despite its higher APR.
| After 5 years | Offer A | Offer B |
|---|---|---|
| Interest paid | $90,840.83 | $98,374.89 |
| Plus upfront fees | $96,840.83 | $99,374.89 |
| Balance still owed | $280,011.83 | $281,627.49 |
After five years Offer A is ahead by $2,534.06. If you expect to move or refinance within about three years, Offer B would have cost less.
The Loan Estimate helps with exactly this. Page 3 has a "Comparisons" table that shows, under "In 5 Years," the total you'll have paid in principal, interest, mortgage insurance and loan costs, and how much principal you'll have paid off. That's set by section 1026.37(l), and it's often a better guide than the APR when you don't plan to stay long.
A note on reading the gap: Offer B's APR is 0.341 percentage points higher, not 0.341% higher. That distinction trips up a lot of rate comparisons, and Percent Change vs Percentage Points explains why.
When the APR can mislead you
- Adjustable-rate mortgages. The APR on an ARM is based on the starting terms. The CFPB warns that "for adjustable rate mortgage loans, the APR does not reflect the maximum interest rate of the loan." Look at the adjustment caps instead.
- Home equity lines of credit. A HELOC's APR doesn't include fees, while a closed-end loan's APR does, so comparing the two by APR alone isn't apples to apples.
- Short holding periods. As the example shows, a loan with high points and a low APR can be the more expensive choice if you leave early.
- Costs the APR leaves out. Title insurance, appraisal and escrow aren't in it. One lender's required title company may cost more than another's.
- Different loan amounts or terms. The APR compares cleanly only when the loan amount and term are the same.
APR on credit cards and other loans
On a credit card, the APR is simply the card's yearly interest rate. As the CFPB's page on credit card interest rates puts it, "for credit cards, the interest rates are typically stated as a yearly rate. This is called the annual percentage rate (APR)." Fees like annual fees aren't folded in. Issuers turn the APR into a daily or monthly rate to charge interest, and your cardholder agreement states the exact method. On most cards you pay no interest on purchases if you pay the full balance by the due date.
Auto loans and personal loans work like mortgages: the APR includes the interest plus finance charges such as an origination fee, so it's the number to compare between lenders.
Savings accounts use a different figure, the APY (annual percentage yield), which includes the effect of compounding. A rate stated as APY and one stated as APR aren't directly comparable.
How to use both numbers
- Use the interest rate to check the monthly payment. Plug the loan amount, rate and term into the Loan Calculator and compare with the quote.
- Use the APR to compare offers for the same amount and term. A large gap between rate and APR means heavy upfront charges.
- Use "In 5 Years" (or your own time frame) if you might sell or refinance. Count fees plus interest over the years you actually expect to keep the loan.
- Read page 2 of the Loan Estimate for the costs the APR leaves out.
To see how much more one offer costs in percent, rather than percentage points, run the two totals through the Percentage Calculator.
FAQ
Why is my APR higher than my interest rate?
Because the loan has finance charges beyond interest, such as points, origination fees or mortgage insurance. The APR spreads those costs over the loan term. If a loan had no such charges, the APR and the interest rate would match.
Is my monthly payment based on the APR?
No. The principal and interest payment is calculated from the interest rate. The APR is a disclosure for comparing the total cost of credit.
Is a lower APR always the better deal?
Not always. It assumes you keep the loan for the full term. If you'll pay it off early, a loan with lower upfront fees can cost less even with a higher APR. ARMs and HELOCs also need more than the APR to compare fairly.
Does the APR include property taxes and homeowners insurance?
No. Amounts paid into escrow for taxes and insurance are excluded. Mortgage insurance that protects the lender is included.
How accurate does the APR on my disclosure have to be?
For a regular loan, Regulation Z treats the disclosed APR as accurate if it's within 1/8 of 1 percentage point of the exact figure, and within 1/4 of a point for irregular loans, such as those with uneven payments.
