Over the past 7 years of being in real estate, there is a common question that is asked by the purchaser at every settlement without fail, “What is the difference between APR and Interest rate?”

This question comes up when the buyer is reviewing the Truth-In-Lending disclosures with the settlement attorney. Then, out of nowhere appears a HUGE number showing the payment of the loan after 30 years!

What’s the Truth-In-Lending disclosure?
Truth-in-Lending disclosures is used to streamline the loan details being presented to homebuyers. The Truth in Lending Act (TILA) of 1968 is federal law designed to encourage the informed use of consumer credit. TILA allows purchasers the ability to cancel certain credit transactions that involve a lien on a consumer’s principal residence, supervises many credit card issues, and provides a forum for fair and timely resolution of credit billing disputes.

What is an APR (Annual Percentage Rate)?
The APR is considered “the interest rate for a year (annualized) as applied on a loan, mortgage loan, credit card, etc. It is a finance fee stated as an annual rate.”

What is an Interest Rate?
Wikipedia considers “the interest rate is the rate at which interest is paid by a borrower for the use of money that they borrow from a lender.”

How does this issue affect YOU?
When the buyer agrees on the note rate with a mortgage lender as the mortgage payment that’s your interest rate. The APR is a percentage when factoring in the cost of the additional finance expenses included with the loan and interest rate.

These finance fees including interest rate are calculated to derive an APR (Annual Percentage Rate). It is computed into a percentage over the life of the loan (ie. 15 or 30 years).

1. Origination fees
2: Points
3: Buydown funds from the buyer
4: Prepaid mortgage interest
5: Mortgage insurance premiums
6: Other lender fees (application, underwriting, tax service, etc.)

If you are new to buying a house, borrowing or have made some mistakes when in the financial market, you might consider learning the lending terms. You hear the words interest rates and APRs and usually your first instinct is to nod you head and think, “whatever”, because ultimately you need the money. However, interest rates and APRs have a major impact on the loans we take out and can also affect our ability to pay back our obligations. Therefore, if you are considering working with a creditor, read up about the details of interest rates and APRs so you can be an educated borrower.

Lost of people today assume that interest rates and APRs are the same thing because both of them charge us money and both of them are something no one really likes. However, the two items are actually different and they impact your loan differently. If you do not understand the differences of the two, you may not be able to pay it back on time. Therefore, before you borrow, educate yourself on the difference between the two.

It is easier for most people to understand interest because interest is more straightforward and simple. For example, when it comes to your mortgage, usually your interest is determined by the principle and the term of the loan. However, many nave people assume this is the only factor affecting interest and the overlook other important factors that can affect interest rates.

Some specific factors usually affect interest including the type of loan you decide to take out - fixed loans, ARM loans, etc. In addition, your mortgage interest rate also considers the amount of your loan versus the value of your home. Lastly, sometimes, interest is factored based off the type of property you are purchasing. The interest will probably be different if the home is your primary residence, a second home, or an investment property.

One of the great things about a mortgage is that you can actually “buy down” the interest rate if you want to. You “buy down” your interest rate by paying points up front. A point usually equals 1 percent of the loan you are buying, so if your loan was $100,000, you could “buy down” five points in interest by paying $5000 dollars up front. Buying down is a great way to not only reduce the interest rate, but also reduce the amount you will pay in the long run, and there are actually possible tax benefits from doing so.

If you do not know how to calculate interest, it is actually quite simple. You divide the total amount of interest charged from the loan by the total amount of the loan; therefore, if your lender loans you $10,000 and charges you $100 in interest your interest rate is (100/10000) x 100 percent = 10 percent. Computing interest rates always simple, even if the numbers are a little bit more complicated.

Moving on from interest rates, APR (short for Annual Percentage Rate) figures the total cost of a mortgage including closing costs and interest over the entire term of the loan. You often hear APR quoted in an annualized for, because APR is a yearly calculation. The nice thing about the APR is that it is a better reflection of the costs to anticipate in the future because it takes into consideration more than just your future interest. It is important not to overlook APR, because if you do, you will overlook important costs that you might not realized are coming in the future.

Since APR considers all costs for the future other than the principle, not just the interest rate, it is usually a higher rate than the interest rate. The calculation for APR is a little more complex than the simple calculation for interest rates and it usually involves an amortization schedule and a more complicated equation. However, because of this APR is a good prediction of future costs.

When you do apply for a mortgage, do not be surprised when both the interest rate and APR are discussed. The rates will definitely vary given you credit score and the conditions of the market. Yet, those who better understand the terms will make more informed decisions when it comes to borrowing.

While interest rates and APRs are definitely based on the market, the controlling costs that come with a new mortgage are definitely something that you have control over. These items are the prepaid items such as the closing costs and mortgage insurance. Work with your lender to negotiate these items, especially given that you have more flexibility with them.

Also, because you are more informed about lending, you should shop around. You might be tempted to go with the first person that offers you a loan, however it might not be the best decision. Research and find the best choice for you.