What is the difference between the interest rate and the APR?

You'll see an interest rate and also an Annual Percentage Rate (APR) for each home loan and mortgage loan that you see advertised. The easy answer to "why" is that federal law requires the mortgage lenders to tell you both numbers.

The APR is a tool for comparing different mortgage loans. This value starts with the actual mortgage rate, but then also incorporates fees and points and other costs as well. The APR is designed to represent the "true cost of a loan" to the borrower, expressed in the form of a yearly rate. This way, lenders can't "hide" fees and upfront costs behind low advertised rates. Or so the theory goes. It works somewhat, but it can be very confusing.

While it's designed to make it easier to compare mortgage lenders, it falls short because the APR includes some, but not all, of the various fees that accompany a home loan. And since the federal law that requires mortgage lenders to disclose the APR does not clearly define what goes into the calculation, APR can vary from mortgage lender to mortgage lender and also from home loan to home loan.

The APR on a loan tied to a market index, like a 5/1 ARM, assumes the market index will never change. But ARMs were invented because the market index does change. This makes an APR disclosure for an ARM almost worthless.

So, APRs are at best inexact. The APR should be used as a guide, but you will likely shortchange your financial interests if you make a decision based on APR alone. An experienced and professional mortgage lender is needed to examine all aspects of the home loan, and purchase or refinance mortgage decision.

Note when you're browsing for loan terms that the APR will not tell you about balloon payments or prepayment penalties, or how long your home loan rate is locked. Also, you'll see that APRs on 15-year mortgage loans will carry a higher relative rate due to the fact that points paid are amortized over a shorter period of time.

Mortgage rates will be slightly higher for no income verification loans, no-doc loans, zero down loans, and mortgage loans for poor credit situations.