APR vs. interest rate: the number lenders hide
Key takeaways
04 · ideas- APR includes fees that the interest rate ignores
- A 5.9% rate with $3,000 in fees can cost more than 6.2% with no fees
- Short-term loans exaggerate the impact of fees on APR
- Always compare APR, not the advertised interest rate
Basic level
The essentials · 1 min
Interest rate = the annual cost of borrowing the principal, expressed as a percentage.
APR (Annual Percentage Rate) = the interest rate plus all fees and costs, also annualized. APR is always ≥ the interest rate.
A lender advertising 5.5% but charging $3,000 in origination fees on a $200,000 loan has an APR closer to 5.8%. The interest rate is not the price — the APR is.
Simple rule: When comparing loans, always use APR. Ignore advertised rates.
The exception: if you'll pay off the loan very early, APR overstates the fee impact (fees are spread over the full term, but if you refi in 3 years, the "annualized" calculation misleads). In that case, calculate total cost instead.
Intermediate level
How it applies · 1 min
What's included in APR?
Included: Origination fees, discount points, mortgage broker fees, prepaid interest (per diem), required mortgage insurance.
NOT included: Appraisal fees, title insurance, recording fees, escrow deposits, voluntary insurance. These are "closing costs" that appear in the Loan Estimate but don't affect APR.
The APR calculation
For a mortgage: APR is the interest rate r^* that makes the present value of all payments (including fees deducted from proceeds) equal to the loan amount.
Solving for r^* gives you the APR.
Example: $200,000 loan at 5.5%, 30 years, $4,000 in fees.
- Monthly payment: $1,136
- Effective loan received: $200,000 − $4,000 = $196,000
- APR = solve for rate where 360 payments of $1,136 discount back to $196,000 = 5.74%
Points: trading upfront cost for lower rate
One "point" = 1% of the loan amount. Paying 1 point on $200,000 ($2,000 upfront) typically buys down the rate by 0.25%.
Break-even on buying a point:- Rate without point: 6.0% → monthly payment: $1,199
- Rate with 1 point: 5.75% → monthly payment: $1,167
- Monthly savings: $32
- Upfront cost: $2,000
- Break-even: 2,000 / 32 = 62.5 months (5.2 years)
If you keep the loan beyond 5.2 years, the point paid off. If you sell or refinance before, you lost money.
Advanced level
The math, step by step · 1 min
Comparing loans with different terms: true cost analysis
APR is only comparable between loans with the same term. A 15-year loan at 5.8% APR vs. a 30-year loan at 5.5% APR are not directly comparable — the 15-year requires higher payments but builds equity faster.
Total cost comparison for $300,000:
| Loan | Rate | Fees | Monthly PMT | Total paid | APR |
|---|---|---|---|---|---|
| 30yr | 6.0% | $0 | $1,799 | $647,514 | 6.00% |
| 30yr | 5.8% | $3,000 | $1,763 | $634,655 | 5.92% |
| 30yr | 5.5% | $6,000 | $1,703 | $619,058 | 5.76% |
| 15yr | 5.5% | $0 | $2,451 | $441,133 | 5.50% |
The 15-year at 5.5% saves $178,000+ over 30-year at 6.0% — but requires $652 more per month. The decision depends on cash flow, opportunity cost (what else could you do with $652/month?), and risk tolerance.
The refinancing trap: Refinancing resets amortization. If you've paid 5 years on a 30-year loan and refinance into another 30-year, you're extending your debt horizon by 5 years. Even at a lower rate, the total interest paid may be higher. Always calculate total remaining interest on the current loan vs. total interest on the refinanced loan — never just compare monthly payments.