Why is APR always higher than the interest rate?

APR is higher because it includes the interest rate PLUS other lender fees, points, and closing costs spread out over the loan term. It is a measure of the TOTAL cost of borrowing. If APR equals the Interest Rate, it means there are zero lender fees.

Which number should I compare when shopping for a loan?

Compare the APR. Lenders can artificially lower their advertised Interest Rate by charging you higher upfront fees (buying points). The APR exposes this trick by combining both into one number. The lower the APR, the cheaper the loan.

Does APR affect my monthly payment?

Technically, no. Your monthly payment is calculated using the *Interest Rate*, not the APR. The APR is just a reference number to help you understand the true cost. However, high fees (which raise the APR) means you pay more cash at closing.

Is specific to mortgages?

No. You will see APR on credit cards, auto loans, and personal loans. On credit cards, the APR is effectively your interest rate because there are rarely upfront closing costs. But on mortgages and auto loans, the distinction is critical.

APR vs. Interest Rate: The Complete Guide

You're looking at loan offers. Lender A offers 6.5%. Lender B offers 6.25%. Lender B is cheaper, right?Not necessarily. This is the trap that catches thousands of borrowers every year. To see the truth, you have to look at the APR.

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Defining the Terms

Interest Rate

This is the cost of borrowing the principal amount. It determines your Monthly Payment.

USED FOR:

Calculating monthly P&I (Principal & Interest).
Amortization schedules.

APR (Annual Percentage Rate)

This is the Interest Rate + Broker Fees + Points + Closing Costs. It represents the Total Cost of the loan.

USED FOR:

Comparing different lenders.
Spotting hidden fees.

The Lender's Trick: "Buying Down the Rate"

Lenders know you are shopping for the lowest rate. So, they might offer you a seemingly magical rate of 5.5% when everyone else is at 6.0%.

How? They charge you Discount Points upfront. One "Point" is a fee equal to 1% of the loan amount ($3,000 on a $300k loan). You pay thousands in cash at the closing table to lower your monthly payment by $50.

The APR reveals this. If the Rate is 5.5% but the APR is 6.2%, you know there are huge fees attached.

Math Example: The $300,000 Mortgage

Let's compare two loan offers for a 30-year fixed mortgage.

Feature	Loan A (Low Rate)	Loan B (Standard)
Interest Rate	6.0%	6.5%
Monthly Payment	$1,798	$1,896
Upfront Fees (Points)	$6,000 (2 Points)	$0
Closing Costs	$3,000	$3,000
APR	6.35%	6.58%

Analysis: Loan A saves you $98/month, but costs you $6,000 extra today. It takes 61 months (over 5 years) just to break even ($6,000 / $98 = 61.2). If you plan to move in 4 years, Loan B is actually cheaper, despite the higher interest rate.

What is included in APR?

The Federal Truth in Lending Act requires lenders to disclose APR. It includes:

✅ Interest Rate
✅ Discount Points
✅ Origination Fees
✅ Mortgage Broker Fees
✅ PMI (Private Mortgage Insurance)
✅ Transaction Fees

What is NOT included?
Third-party fees that you would pay regardless of the lender, such as:

❌ Title Insurance
❌ Home Inspection
❌ Appraisal Fee
❌ Property Taxes

When to Ignore APR

There is one specific scenario where APR is misleading: Adjustable Rate Mortgages (ARMs).

With an ARM, the APR is based on the initial fixed period (e.g., first 5 years) and a forecast of future rates. Since nobody can predict interest rates 10 years from now, the APR on an ARM is essentially a guess.

Consumer Advice: How to Shop

Get a Loan Estimate (LE): When you apply, the lender MUST give you this standardized form within 3 days.
Look at Page 1: Check "Interest Rate" and "Monthly P&I".
Look at Page 3: Check the "APR" and "Total Interest Percentage (TIP)".
Compare 3 Lenders: Compare APRs. If one APR is significantly higher, ask "What fees are baked into this?"

Conclusion

Interest Rate determines your Monthly Payment.
APR determines the Total Cost of the Deal.

Never choose a loan based on the interest rate alone. You might be paying thousands in upfront fees for a "discount" that you won't live in the house long enough to enjoy.