APR vs interest rate: how to compare mortgage offers
Every mortgage offer shows two percentages. The interest rate sets your monthly payment; the APR (annual percentage rate) folds in the lender's fees and points so you can compare the true cost of different offers. Here's how they relate, where APR can mislead you, and how to decide whether paying points up front is worth it.
The interest rate: what sets your payment
The interest rate (sometimes called the note rate) is the percentage the lender charges on the money you owe. Divide it by 12 and you get the rate applied to your balance each month. It's the number you enter in a mortgage calculator to get your principal and interest payment.
What the rate doesn't show is what you paid to get it. Two lenders can quote the same 6.75% while one charges $1,000 in fees and the other $7,000.
The APR: the rate plus the cost of getting it
The APR expresses the cost of the loan — interest plus certain upfront charges — as a single yearly rate. Under the federal Truth in Lending Act, lenders must disclose it, and it's calculated the same way everywhere, which is what makes it useful for comparing offers.
APR generally includes:
- Discount points and origination or underwriting fees
- Mortgage insurance premiums, such as PMI or FHA premiums
- Prepaid interest and some other lender charges
It generally excludes third-party costs such as the appraisal, credit report, title insurance and recording fees. So APR is a better comparison tool than the rate alone, but it isn't the full cost of closing.
Example: how fees turn into APR
A $320,000, 30-year loan at 6.75% has a payment of $2,075.51. If the lender charges $6,400 in points and fees, you effectively receive $313,600 but repay as if you'd borrowed $320,000. Solving for the rate that matches those payments to the money you really received gives an APR of about 6.95%.
A second lender quoting 6.875% with almost no fees would have an APR only slightly above 6.875% — lower than the first offer, despite the higher rate. That's the comparison APR is built for.
Where APR can mislead you
- It assumes you keep the loan for the full term. Upfront fees are spread over 30 years in the APR. If you sell or refinance after 7 years, the same $6,400 is spread over far fewer payments: in the example, the effective annual cost rises from about 6.95% to about 7.13%. If you expect to move or refinance soon, favor low fees over a low rate.
- On ARMs, it assumes the index stays where it is today. The APR of an adjustable-rate loan says nothing about what happens when the rate resets (see fixed vs ARM).
- It doesn't include every closing cost. Always compare the full Loan Estimate, not only the APR (our guide to closing costs explains each section).
Discount points: paying now to save later
A discount point costs 1% of the loan amount and lowers your interest rate. How much each point lowers the rate varies by lender and market conditions; a quarter of a percentage point per point is a common rough figure. Whether points pay off comes down to one number: the break-even point.
Break-even (months) = cost of points ÷ monthly payment savings
| Option on $320,000 | Upfront cost | Rate | Payment | Monthly savings | Break-even |
|---|---|---|---|---|---|
| No points | $0 | 6.75% | $2,075.51 | — | — |
| 1 point | $3,200 | 6.50% | $2,022.62 | $52.90 | ≈ 61 months |
| 2 points | $6,400 | 6.25% | $1,970.30 | $105.22 | ≈ 61 months |
In this example, points take about five years to pay for themselves. If you keep the loan longer, every month after that is savings; if you sell or refinance sooner, you lose money on them. Points are also cash you can't use for your down payment, emergency fund or moving costs.
The reverse: lender credits
Lenders also offer the opposite trade: a slightly higher rate in exchange for a credit that covers some of your closing costs. The break-even logic runs in reverse — credits make sense if you expect to move or refinance before the higher payment adds up to more than the credit you received.
How to compare offers, step by step
- Request Loan Estimates from at least three lenders on the same day, for the same loan amount, term and loan type.
- Check page 3 of each Loan Estimate, which shows the APR and the total you'll have paid in the first five years.
- Look at section A (origination charges) to see how much of each APR comes from points and fees.
- Decide how long you realistically expect to keep the loan, and compute the break-even for any points.
- Enter each rate in the calculator to see the monthly payment you'd actually budget for.
Turn a rate into a payment. Enter each offer's interest rate to compare monthly payments and total interest.
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