The interest rate is the cost of borrowing the principal. APR (Annual Percentage Rate) is the interest rate plus fees, expressed as an annual percentage. APR is always equal to or higher than the interest rate. Lenders are required by US law (Truth in Lending Act) to disclose both, because APR is the right comparison number when shopping for loans.
The interest rate, simply
The interest rate is what you pay on the loan principal. A $300,000 mortgage at 6.5 percent interest rate means you pay 6.5 percent of the outstanding balance each year as interest. The monthly interest is the annual rate divided by 12. Your monthly payment is calculated from the interest rate, not the APR.
Interest rate is the number that determines your monthly payment. If you focus on cash flow, the interest rate matters most.
The APR, with fees included
APR includes the interest rate plus annualized upfront fees: origination fees, discount points, mortgage insurance, and certain closing costs. By spreading the fees over the life of the loan, APR shows the true annualized cost of borrowing.
Example: $300,000 mortgage at 6.5 percent interest rate with $5,000 in fees. The interest rate is 6.5 percent. The APR is approximately 6.78 percent. The 0.28 percent gap represents the $5,000 in fees spread over 30 years.
Why two numbers?
The interest rate alone is misleading when comparing loan offers because fees vary widely. Lender A may offer 6.0 percent with $10,000 in fees; Lender B may offer 6.5 percent with $1,000 in fees. The lower rate looks better, but Lender B might actually cost less over the life of the loan. APR normalizes for fee differences so you can compare apples to apples.
For a 30-year hold, comparing APR usually picks the right loan. For a short hold (selling in 5 years), APR overstates the cost of fee-heavy loans because the fees never get fully amortized. In that case, total cost over the actual holding period is the right comparison.
What is included in APR (for US mortgages)
Truth in Lending Act regulations specify what goes into APR:
- Included: Origination fees. Discount points. Mortgage broker fees. Pre-paid mortgage insurance premiums. Other lender-imposed fees as required by law.
- Not included: Title insurance. Appraisal fees. Credit report fees. Recording fees. Attorney fees. Survey fees. Most government fees. Prepaid interest, property taxes, and homeowners insurance escrow.
The line between "included" and "not included" isn't always intuitive. Generally, fees paid to the lender are in APR; fees paid to third parties (title company, appraiser, attorney) are not.
Worked example: comparing two mortgage offers
| Lender A | Lender B | |
|---|---|---|
| Loan amount | $300,000 | $300,000 |
| Interest rate | 5.75% | 6.25% |
| Origination fee | $3,000 | $500 |
| Discount points (1 point = 1%) | $3,000 (1 point) | $0 |
| Mortgage insurance (if applicable) | $0 | $0 |
| Total upfront cost | $6,000 | $500 |
| Approx APR | 5.99% | 6.28% |
| Monthly payment (P&I) | $1,751 | $1,847 |
If you hold the loan 30 years, Lender A is cheaper despite the upfront fees. If you sell in 5 years, the points and origination fees never pay off and Lender B becomes cheaper. The break-even point is around year 8-10 for this example.
Credit cards work differently
Credit cards do not have upfront fees built into their APR. Card APR equals the interest rate. The complication with cards is daily compounding: a 24 percent APR translates to a daily periodic rate of 0.066 percent compounded every day on the unpaid balance, which produces an effective annual yield (APY) of about 27.1 percent.
So credit card APR understates the true cost slightly (because of compounding). Loan APR includes fees but ignores compounding (because installment loans pay off interest each month). The two APRs measure different things and are not directly comparable.
How to use APR when loan shopping
Step 1: Get loan estimates from at least 3 lenders. Federal law requires standardized Loan Estimate forms that show both interest rate and APR clearly.
Step 2: Compare APR-to-APR among offers with the same loan term and structure (fixed vs adjustable).
Step 3: For short holding periods (under 7 years), also compute total cost = monthly payment × number of months + upfront fees. Use our loan calculator to check.
Step 4: Pick the loan with the lowest total cost over your expected holding period, which usually but not always corresponds to the lowest APR.