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

For each mortgage loan you see advertised, you'll see an interest rate and an Annual Percentage Rate (APR). The easy answer to "why" you see two rates is that federal law requires the lender to disclose both.

The APR is a tool for comparing different loans, which will include different interest rates, as well as different points and other terms. 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 cannot "hide" fees and upfront costs behind low advertised rates.

While it's designed to make it easier to compare loans, it's sometimes confusing because the APR includes some, but not all, of the various fees and insurance premiums that accompany a mortgage. And since the federal law does not clearly define what goes into the calculation, APRs can vary from lender to lender and loan to 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 changes and makes fixed rate loans cheaper or more expensive to make – that's why they're called variable rates in the first place!

So, APRs are at best inexact. The lesson is that APR can be a guide, but you need a mortgage professional to help you find the truly best loan for you.

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