Difference Between Interest Rate APR – The Real Cost of Financing

Difference Between Interest Rate APR

Difference Between Interest Rate APR

Interest rates always seem to be the focus when searching for mortgage financing.  People tend to check with their neighbors, family, and friends to compare experiences.  What they find is that no two experiences are the same.  Your neighbor closed on a thirty year fixed loan at 3.5% while your sister transacted the same terms at 4.0%. One wonders why the neighbor did so much better. What you will learn in each situation is that there is a difference between interest rate APR. (Annual Percentage Rate).Difference Between Interest Rate APR

The mistake people make is not knowing there is more to mortgage interest rates than the quoted rate.  The rate offered is not actually what you get. Understanding the difference will help get you through the difficult mortgage process.  What people don’t understand is that a mortgage transaction is like any other.  In that, you always get what you pay for. With mortgage financing, the rate is what you end up paying.  And, if done correctly, a well-structured loan is what you actually receive in return.

The Total Cost of a Loan – Rates Points and Fees

There are three things that make up the actual mortgage transaction. They include rate, points, and fees.  Rate, points, and fees are the three main price components of a mortgage
financing deal.  In exchange for these price components, a loan is what you end up receiving.  The loan or what you receive is the sum of what you owe after including the costs and fees financed.
 
Now that you see that interest rate APR are two separate things. It will help you know the real cost versus the lowest cost when comparing mortgage financing.

Mortgage lending transactions contain two terms to explain the difference between interest APR.  The amount financed and the loan amount.  In fact, the actual amount borrowed before costs and fees equals the amount financed. The loan amount is what you actually owe after including costs and fees financed in the loan.  The amount financed is the amount of money you actually get and the loan is the amount you actually owe.

Monthly Payment Versus the Total Cost of a Loan

In a mortgage loan transaction, it is common to finance the closing fees and costs as part of the loan.  This can be to your benefit by keeping closing costs low, you don’t have to pay them out of pocket.  The negative to financing your fees is that you pay extra interest over the life of the loan.  The impact is that it changes the effective interest rate of the financing.  As a result, the costs and fees cause the loan amount and monthly payment to increase.  The step up in monthly payment alters the real cost of the loan compared to the amount financed.
Difference Between Interest Rate APR
This is the main reason APR and interest rate are two separate things. In fact, if the amount financed equals the loan there is no difference between interest rate APR. The APR is always the amount financed and the interest rate is always the loan amount.
 
To illustrate, the following table shows the difference between interest rate APR.  The table shows the total cost of financing at different time intervals at a quoted rate of 4.50%. Also, it displays the difference between interest rate APR at many levels of points and fees.

 

The difference in rate is what your monthly payment will be, while APR calculates the total cost.  A borrower can use either or in a like-kind comparison of rates when shopping for a loan. If a borrower wants to get the lowest monthly payment they should focus on the interest rate. If a borrower cares more about total costs then they can use the APR to look at the total cost of many loans.

 

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