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The Difference between Interest Rate and APR

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    When you get a mortgage, you are charged two different rates--the annual percentage rate (APR) and the interest rate. Understanding the difference between the two rates is important and will help you make an informed decision when shopping for the appropriate lender and the right loan for you.

    Interest Rate
    The interest rate is the yearly rate a lender charges for permitting the borrower to use money for a specific length of time. The rate is calculated by dividing the total amount of interest charged by the loan amount. For example, if a lender charges a customer $60 a year on a loan of $1000, then the interest rate would be (60/1000) x 100% = 6%.

    Annual Percentage Rate
    Annual percentage rate (APR) is the annual interest rate you pay on your loan and is the rate used to calculate your monthly payments. The amount of interest you pay is only one of the costs associated with your loan; there may be others.

    Your APR includes both your interest and any additional costs or prepaid finance charges you might pay such as prepaid interest, private mortgage insurance, closing fees, points, etc. It represents the total cost of credit on a yearly basis after all charges are taken into consideration.

    It will usually be slightly higher than your interest rate because it includes these additional items and assumes you will keep the loan to maturity.

    When shopping for a mortgage--especially if it's your first time--it's important to understand the terminology surrounding the mortgage process. So do your research. Find out as much as you can so that you understand the loan process to make an educated and informed decision when it comes time to choose a loan and lender.

    By Diane Tuman

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    • Last edited October 12 2012
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