APR vs. Interest Rate

When reviewing loan offers, buyers often encounter two similar percentages: the interest rate and the annual percentage rate, or APR. Although related, they measure different things, and understanding the distinction can help you compare offers more accurately.

What the interest rate measures

As covered in the previous lesson, the interest rate is the percentage charged on the loan balance to calculate the interest portion of each payment. It does not include most other costs associated with obtaining the loan.

What APR adds

Because APR bundles in additional costs, it is often presented as a way to compare the "true" cost of different loan offers, beyond just the headline interest rate.

Why the two numbers can differ

A loan with a lower interest rate might have higher upfront fees, resulting in a higher APR than a loan with a slightly higher interest rate but lower fees. This is why comparing only interest rates can be misleading when loans have different fee structures.

What APR does not capture perfectly

Additionally, not every fee associated with a mortgage is necessarily included in the APR calculation, and rules about what must be included can vary, so it remains useful to review the full breakdown of costs on your loan estimate rather than relying on APR alone.

Using APR to compare offers

APR can be a helpful tool when comparing loan offers of the same type and term from different lenders, since it accounts for more than the interest rate alone. However, it works best as one of several tools, alongside comparing the full loan estimate, rather than the sole basis for a decision.

A common mistake

Understanding both the interest rate and APR, and how they relate, equips you to ask better questions when comparing loan estimates, a skill covered further in the next lessons of this module.