Interest rate vs. APR: Know the difference to keep closing costs down

Purchasing a home is a significant financial milestone, but along with the excitement comes the reality of closing costs. These costs cover various fees associated with finalizing the home purchase.

There are many strategies to lower your overall closing costs, but in this blog post, we’ll focus on two key terms — interest rates and APR (Annual Percentage Rate).

These two concepts are similar yet different, so it’s very important to understand them when shopping around and comparing loan products.

What does an interest rate include?

The interest rate is the percentage of the loan amount that a lender charges the borrower for borrowing the money. It's the cost of borrowing the principal amount and is expressed as a yearly percentage. In the case of mortgages, the interest rate determines the amount of interest you'll pay over the life of the loan, and it directly affects your monthly mortgage payment.

For example, if you have a mortgage with a principal amount of $200,000 and an interest rate of 4%, you'll pay $8,000 in interest in the first year of the loan.

What does an APR include?

The APR, on the other hand, is a broader measure that includes not only the interest rate but also various other costs associated with the loan, such as

• Origination fees: Essentially a service fee the lender charges to cover the cost of processing a loan application and creating the loan.
  -Broker fees. Charges by the mortgage broker who works on your behalf to secure the loan best suited for you.
• Private Mortgage Insurance: A type of insurance that lenders require borrowers to pay if they put down less than 20% for a down payment.
• Discount points: A fee that can be paid upfront to a lender in exchange for a lower interest rate on a mortgage loan.
• Closing costs. A catch-all term for the little things that get added to mortgages and are paid upfront. APR includes some of these closing costs.

The APR provides a more comprehensive picture of the true cost of borrowing because it takes into account both the interest rate and these additional fees. The APR is designed to help borrowers compare loan offers from different lenders more effectively.

What's not included in the APR?

Though it’s still a valuable tool for comparing loans, you should be aware that it might not capture every possible expense. For example, the APR typically does not include ancillary costs like home inspection and appraisal costs, HOA dues, title insurance, and credit report fees.

How can I know all my closing costs?

To get a clear picture of all the expenses, we strongly recommend you request the lender send you a list of all the closing costs. We advise against working with any lender who is not willing to provide that information.

Bottom Line

If both lenders/mortgage brokers are offering the same interest rate, then compare the APR for each loan and examine what fees are included in the APR calculation.

Need an experienced attorney for your next closing?

At Pederson Real Estate Law, attorney Charlene Pederson has over 25 years of experience guiding Connecticut clients through residential real estate transactions. If you need an experienced, attentive attorney for your closing, reach out today for a free consultation.