Understanding APR and Interest Rates

It's important to understand terms referring to how much a mortgage loan will actually cost. You'll want to know the difference between mortgage interest rates and annual percentage rates (APR), and understand if and how interest rates can change.

Now and Later: How Interest Rates Can Change

When looking for a mortgage loan, it's essential to consider more than getting a loan that will "get your foot in the door" of your new home. Although fixed rate mortgage loans are available, many homebuyers opt for adjustable rate mortgage loans (ARMs) that offer lower initial payments. Lower payments do not necessarily equate to lower overall cost, and interest rates can change. How and when they change may not be clear to homebuyers; getting mortgage preapproval before home shopping assists in avoiding misunderstandings later.

Interest Rates and APR Aren't the Same

The interest rate your lender quotes you may be 5%, and it may cost you a couple of points to get it. Another loan might feature a rate of 5.25% but only cost 1 point. How do you compare the two? That's where the APR comes in. It expresses the cost of the loan as a percentage rate, including the interest but also the other lender charges like points and fees. The APR is generally higher than the quoted interest rate. While there are plenty of exceptions to this rule, in general if one loan carries a significantly lower APR than another loan then it's the better deal. Keep in mind that APRs can only be compared between loans with the same terms -- 30-year-fixed to 30-year-fixed, 5/1 ARM to 5/1 ARM, and so on.

What are "Points"?

"Points" are common lender charges that increase the APR of a mortgage. A point is one percent of the loan amount. Using the example of a $100,000 mortgage loan, a point would be $1000. Lenders may charge points for a variety of reasons including "locking in" a low interest rate, as a surcharge to borrowers with bad credit, or to "buy down" or get a lower interest rate. Most loans are available with no points although you will pay a higher interest rate. An APR calculator can help you see if it is worth paying points to get a lower rate. You may find that you have to buy your rate down in order to qualify for your mortgage. The preapproval process can tell you if this is the case.

Free mortgage calculator tools can provide general information about affordability, payment amounts, and other mortgage information, but getting mortgage preapproval can save time and money. Preapproval provides the opportunity to consider several mortgage loan options before selecting the one that works best for you.

Karen Lawson
Karen Lawson is a freelance writer with extensive background in mortgage banking. She holds BA and MA degrees in English from the University of Nevada, Reno.