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How does the mortgage rate differ from APR?

Q: Why is there a difference between the mortgage rate and the APR, and which should I be looking at when I compare mortgages?

A: APR stands for Annual Percentage Rate, and measures the total annual cost of the loan as a percentage of the amount borrowed. The mortgage rate is by far the biggest component of that cost, but it isn't the only component. Up-front costs such as points and fees are also factored into the APR, which spreads those costs out over the life of the loan and adds them to the mortgage rate.

This helps with the fact that mortgage quotes often seem like comparing apples and oranges. For example, you might get one mortgage quote with a lower interest rate but higher up-front fees. How do you compare this to a quote that will cost you less up front but charge you more interest over the life of the loan? The APR gives you a basis for that comparison by combining both the interest rate and the up-front charges.

The only complication stems from the fact that the timing of these payments differs. The fact that you pay points and fees up front while your mortgage rate is charged over the life of the loan will skew the comparison if you pay the loan off early -- which includes partial prepayments as well as refinancing a mortgage. In those cases, any up-front charges would be incurred over what would effectively be a shorter-term loan, meaning up-front charges may be a bigger component of APR than they seem for a loan you pay off early.

Also, between two loans with the same APR, the one with lower up-front fees is probably better, because you'll be paying more of that APR later on in the loan rather than up front.

In short, APR is a useful comparison, but the more likely it is you will pay off the loan early, the more you should shy away from up-front costs.

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