APR, or annual percentage rate, is the total yearly cost of borrowing expressed as a percentage. It’s higher than your mortgage interest rate because it folds in fees you pay to get the loan, not just the interest itself. Think of the interest rate as the price of borrowing the money, and the APR as the price of borrowing the money plus the cost of setting up the loan.
How APR Differs From Your Interest Rate
Your mortgage interest rate determines how much interest accrues on your loan balance each month. If you borrow $300,000 at a 6.5% interest rate on a 30-year fixed mortgage, your monthly principal and interest payment is about $1,896. That payment is calculated purely from the interest rate.
The APR takes that same interest rate and layers on certain upfront costs you paid to secure the loan, then spreads them across the full loan term as if they were additional interest. On that same $300,000 mortgage, if you paid $6,000 in fees that get folded into the APR, the APR might come out to roughly 6.7%. Your actual monthly payment doesn’t change, but the APR gives you a more complete picture of what the loan costs per year when those fees are factored in.
The gap between the interest rate and the APR tells you something useful: the bigger the gap, the more you’re paying in upfront costs. A loan quoted at 6.25% with an APR of 6.9% carries significantly more in fees than one quoted at 6.5% with an APR of 6.6%.
What Costs Are Included in the APR
The APR reflects the interest rate plus points, mortgage broker fees, and other charges you pay to get the loan. According to the Consumer Financial Protection Bureau, lenders must bundle these borrowing-related costs into the APR calculation. Here’s what typically gets included:
- Discount points: Upfront fees you pay to buy a lower interest rate. One point equals 1% of the loan amount, so on a $300,000 mortgage, one point costs $3,000.
- Origination fees: What the lender charges to process and underwrite your loan, often 0.5% to 1% of the loan amount.
- Mortgage broker fees: If a broker arranges your loan, their compensation gets rolled into the APR.
- Mortgage insurance premiums: If your down payment is less than 20%, private mortgage insurance (PMI) premiums may be included in the APR calculation.
- Prepaid interest: The per-day interest that accrues between your closing date and the start of your first full payment period.
What Costs Are Not Included
Not every closing cost shows up in the APR. Fees charged by third parties that your lender doesn’t require or benefit from can be excluded from the calculation. In practice, this means several costs you’ll see on your Closing Disclosure won’t affect the APR:
- Title insurance and title search fees
- Appraisal fees
- Home inspection costs
- Recording fees and transfer taxes
- Homeowners insurance
- Property taxes
Taxes, license fees, and registration fees that both cash buyers and financed buyers would pay are generally not treated as finance charges. Late payment fees and other penalty charges are also excluded. This is worth knowing because it means the APR, while more comprehensive than the interest rate alone, still doesn’t capture every dollar you’ll spend at closing.
Why APR Matters When Comparing Loans
The APR exists specifically to help you compare loan offers on equal footing. Two lenders might both quote you a 6.5% interest rate, but if one charges $4,000 in origination fees and the other charges $8,000, their APRs will be different. The lender with lower fees will have a lower APR, signaling that the loan is cheaper overall.
Federal law requires lenders to disclose the APR on your Loan Estimate, which you receive within three business days of applying, and again on your Closing Disclosure before you finalize the loan. If the APR changes significantly between those two documents, the lender must give you a corrected Closing Disclosure at least three business days before closing, giving you time to review the change and decide whether to proceed.
Where APR Can Be Misleading
The APR calculation assumes you’ll keep the loan for its entire term. On a 30-year mortgage, it spreads those upfront fees across all 30 years. If you sell the house or refinance after seven years, those fees were actually concentrated into a much shorter period, making the true cost of borrowing higher than the APR suggested.
This matters most when you’re deciding whether to pay points. Say you pay $6,000 in points to drop your rate from 6.75% to 6.25%. The APR makes that look reasonable spread over 30 years. But if you move in five years, you paid $6,000 to save on interest for only 60 months, and the savings may not have covered the cost. The shorter you plan to stay in the home, the less useful the APR is as a comparison tool and the more you should focus on minimizing upfront fees.
APR can also vary between lenders not because of different pricing, but because of slightly different interpretations of which fees to include. While federal rules set the framework, some gray areas exist. If two APR quotes look nearly identical, it’s still worth comparing the itemized fee breakdowns on each Loan Estimate line by line.
How to Use APR When Shopping for a Mortgage
Start by requesting Loan Estimates from at least three lenders for the same type of loan (same term, same loan amount, same type of rate). Compare the APRs side by side, but don’t stop there. Look at the gap between each lender’s interest rate and APR. A small gap means lower fees. A large gap means you’re paying more upfront for the loan, which only pays off if you keep the mortgage long enough for the lower rate to generate savings.
If you plan to stay in the home for the full loan term or close to it, a lower APR is generally the better deal, even if the upfront costs are higher. If you expect to move or refinance within five to ten years, prioritize a lower-fee loan with a smaller rate-to-APR gap, even if the interest rate is slightly higher. The money you save on fees today may outweigh the small amount of extra interest you pay over a shorter horizon.
Finally, remember that APR applies to fixed-rate and adjustable-rate mortgages differently. On an adjustable-rate mortgage (ARM), the APR is calculated based on assumptions about how the rate will adjust in the future. Since no one knows exactly where rates will go, the ARM’s APR is an estimate, not a guarantee. For fixed-rate loans, the APR is straightforward because the rate never changes.