When applying for a mortgage, your mortgage documents will include both the interest rate and the annual percentage rate (APR). These rates are also reflected on your loan estimate.

What is the difference between the interest rate and APR?

The interest rate is the annual cost of the loan expressed as a percentage rate. This is the rate from which your mortgage payment is calculated.

The APR, or annual percentage rate, is expressed as a percentage rate, however the APR includes other mortgage costs such as discount points, origination fees, mortgage insurance, and most closing costs. The APR is the actual cost of the mortgage including fees which is why this rate is higher than the interest rate.

When you apply for a mortgage, your loan officer is required to provide you with a loan estimate which explains your mortgage terms, interest rate, fees, and other costs associated with obtaining a mortgage. On page three of this loan estimate there is a Comparisons section. This section will show the APR and how much the mortgage will cost in the first five years of the loan. You can also compare several mortgage options with your loan officer and discuss how APRs can differ depending on the costs associated with each type of loan.

If you would like to calculate your APR, add the fees to your loan amount. Next, figure out what the monthly payment would be (including fees) and then convert the payment into an interest rate. You can also use an APR calculator or ask your loan officer to help you.

Bottom line: It's important to note that the interest rate is what your monthly payment is calculated upon, not the APR. Depending on the type of mortgage you apply for and fees associated, the APR will vary. For example, some borrowers may want to have discount points added to buy down their interest rate and enjoy a lower monthly payment. In this case, the APR could be higher than a mortgage with no points, because the cost of the points is calculated into the APR.

Source: Mortgage Market Guide