Do you know the difference between mortgage interest rates and annual percentage rates (APR)? These rates are very similar in that they are both used to express the cost of borrowing money for a home loan. In fact, many people, even within the real estate industry, effectively use these terms interchangeably. No wonder so many homebuyers are surprised to find that mortgage interest rates and APR are two different things. But understanding the difference between mortgage rates and APR can potentially save you a lot of money on your home loan. 

In this article, you’ll learn what mortgage interest rates and APR are and how they differ. More importantly, you’ll learn how to evaluate these critical figures when shopping for a home loan. This information can ultimately save you money by helping you to choose the loan option with the lowest total fees.  

What Are Mortgage Interest Rates? 

A mortgage interest rate is simply the cost of borrowing money for a specific period of time.[1] This cost is expressed as a percentage of the loan amount. 

If, for example, you have an interest rate of 7%, this means you would theoretically pay 7% of the loan balance in interest each year. 

Interest rates can be “fixed” or “adjustable.” 

Fixed rates do not change over the term of your loan. The rate is locked in. For example, if you have a 30-year, fixed-rate mortgage with a 7% interest rate, the rate remains 7% throughout the entire loan. Having said that, it’s important to note that you can potentially change the rate by refinancing your mortgage. Refinancing is when you replace your existing mortgage with a new mortgage under new terms. This is why you often see many homeowners refinancing when interest rates decline sharply.    

Adjustable rates fluctuate with the market within pre-set parameters. For example, if you have a 5/1 adjustable-rate mortgage (ARM), your rate would be set for the first five years and then adjusted to current market rates every year thereafter (possibly with caps to prevent excessive increases in mortgage payments). ARM rates always consist of an “index” plus a “margin".[2] The index is the benchmark rate that reflects current economic conditions. The margin is the lender’s mark-up over the benchmark. The margin is set when the loan is originated and will not change from one adjustment period to the next.  

Whether you currently have a fixed or adjustable rate, a PNC mortgage loan officer can help you determine if you might benefit from a refinance and make you aware of other potential options that may be available to you.

What Is Mortgage APR? 

The mortgage APR is the total cost of borrowing money, including the interest rate, plus all other applicable fees you pay to secure the loan[1] including:

  • Private mortgage insurance (PMI). PMI is an insurance policy that allows buyers to purchase a home with less than 20% down by offering some protection for the lender in case of default.   
  • Origination fees. Origination fees are the charges associated with issuing a new loan. These fees cover tasks like underwriting and administrative processing.[3]
  • Mortgage broker fees. Mortgage brokers work on behalf of homebuyers to find suitable lenders offering favorable loan terms. Their service fee is included in the APR because it is a cost of securing suitable financing. 
  • Mortgage points. Mortgage points are discounts on the interest rate. Homebuyers can purchase a mortgage point (also called a discount point) upfront to reduce the interest rate. 

The Difference Between Mortgage Interest Rates and APR

Mortgage interest rates reflect only the agreed-upon cost of borrowing money for a set period of time, while the APR reflects the interest rate plus all other fees and expenses associated with securing the loan. 

This is why the APR is usually higher than the mortgage rate; the APR includes financing charges that are not reflected in the interest rate. 

Mortgage Rate Vs. APR: Which Matters More?

Mortgage rates and APR are both important factors to consider when shopping for a home loan. You may choose to give slightly more weight to the APR since it provides a more complete picture of the cost of the loan.

How Are Interest Rates Calculated?

Interest rates are calculated based on several factors, including economic conditions, lender criteria, and borrower financials.  

Interest rate calculations start with the “federal funds rate.” This is the benchmark rate set by the U.S. Federal Reserve (the Fed) to reflect changing market conditions.[4] The Fed raises and lowers this federal funds rate to stimulate the economy or combat inflation. Banks then use the federal funds rate to establish their “prime rate.” This is the lowest rate they can offer on loans to qualified borrowers.[5]

From here, individual lenders use complex formulas to determine the rates they can offer on various loan types, from personal loans to mortgage loans. 

Borrowers have no control over the federal funds rate and resulting prime rates and various loan rates, but there are additional factors that borrowers have some control over…      

Factors That Determine Your Interest Rate

From the base loan rates that each lender sets following the federal funds rate changes, your unique rate offer is calculated based on your:[6]

  1. Chosen loan type. Different mortgage types offer different interest rates. Keep this in mind when exploring the five main types of home loans. 
  2. Chosen loan term. Interest rates are typically lower for shorter mortgage loan terms. So you might be able to get a better rate for a 15-year mortgage than a 30-year mortgage.
  3. Credit score. A higher credit score is associated with less risk. So a lender may be able to offer a lower interest rate to buyers with higher credit scores. 
  4. Debt-to-income ratio (DTI). The amount of your current debt payments (student loans, auto loans, credit card bills, etc.) is compared to your income to see what percentage of your income is allocated to repaying these debts. Generally, a lower DTI indicates a lower-risk borrower, so a lender may be able to offer a lower interest rate for a lower DTI. 
  5. Down payment amount. You might be able to get a lower interest rate by paying a larger down payment.  
  6. Location. Lenders may offer slightly different rates for different states and regions.
  7. Home price and loan amount. Particularly expensive homes may come with higher interest rates. A jumbo loan, for example, which serves buyers who need to borrow more than the conforming loan limits, may have a higher interest rate than a conforming loan.  

How Is APR Calculated?

As discussed, APR is your interest rate plus the other fees and costs associated with securing your home loan. Here is a review of the factors that determine your APR.

Factors That Determine Your APR

  • Your interest rate
  • The lender’s origination fees
  • Any mortgage points you buy
  • Any mortgage insurance premiums you pay
  • Any other miscellaneous fees or charges necessary for securing your loan

How To Think About Interest Rates and APR When Shopping For A Mortgage

As you shop for a mortgage, consider both the interest rate and the APR. The Truth-in-Lending Act requires that both figures be disclosed before you commit to the loan.[7] You should be able to review a loan estimate with this information within a few days of submitting your mortgage application. And you should receive a closing disclosure to reiterate this information a few days before closing on your new home.

Here are a few tips for reviewing the mortgage rates and APR as you compare home loan offers:[1]

  • You may want to focus on the APR since this is the more comprehensive figure, including all costs associated with the loan.
  • When reviewing APR and interest rates on adjustable-rate mortgages, remember that the figures do not reflect the maximum interest rate allowable by the loan. 
  • Take extra care when comparing adjustable-rate mortgages to one another or to fixed-rate mortgages. The exact charges and fees over the loan term are inherently uncertain at the beginning of an ARM loan term. 
  • Also take extra care when comparing shorter-term mortgages to longer-term mortgages as the loan term can impact both interest rates and fees.

The Bottom Line

Mortgage interest rates and APR both measure the cost of borrowing the money needed to purchase your home. APR is the more inclusive figure, adding all financing fees and charges to the interest rate to give you a fuller understanding of the true cost of borrowing. 

You can learn more about getting a home loan and even start your mortgage application online with PNC Bank.