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What is Interest Rate and APR?

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Mortgage interest rate APR is a key factor in determining your monthly mortgage payments and in determining how much you will pay for your mortgage over the life of your loan. While many people are familiar with mortgage interest rates, it is essential to understand exactly how mortgage interest rate APR works before originating a mortgage loan.

What is Mortgage Interest Rate APR

An interest rate is a fee that a person pays to borrow money. Any time you borrow money from a lender, whether it is to buy a home or car or when you make a purchase on a credit card, you must pay interest or that privilege. The money that you are borrowing is the lender’s capital or an asset that belongs to the lender. Assets can be in the form of cash, stock shares, items in finance lease agreements or consumer goods purchased through a goods for hire purchase. When a lender issues a mortgage loan, the lender is letting the borrower borrow cash assets. The lender does not have access to these assets while the borrower is using them. The interest rate is the fee the borrower pays for the convenience of having that asset.

APR, on the other hand, is the acronym for “Annual Percentage Rate.” The annual percentage rate is the yearly interest rate that is charged on the money you borrow. The APR can be nominal or effective. An effective interest rate is the actual rate of interest you pay if interest is compounded more than once a year (i.e. if you are charged interest on a monthly basis). The nominal interest rate is the interest rate stated in the contract that does not adjust to factor in inflation or compounding.

Types of Interest Rates

There are several different types of interest rates, including:

  • Variable interest rates: An interest rate that changes at set intervals based on a financial index such as the LIBOR index. In mortgage terms, mortgages that use a variable mortgage interest rate APR are called adjustable rate mortgages (ARMs)
  • Fixed interest rate: An interest rate that stays the same for the life of the loan unless the buyer refinances the loan.

Lenders must disclose the mortgage interest rate APR prior to finalization of the loan, and different lenders calculate the APR differently. Your APR is usually printed on the good faith statement from a mortgage company. You can compare the mortgage interest rate APR among lenders in order to determine which lender is charging you the lowest rate to borrow money to buy your home.

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