When comparing mortgage options, you’ll almost always see two percentages quoted: the interest rate and the APR (Annual Percentage Rate).
While they may seem similar at first glance, they serve different purposes. Understanding the difference can help you make more informed financing decisions and avoid comparing loan offers based solely on the interest rate.
More importantly, it can help you determine which loan is actually the better fit for your investment goals.
What Is an Interest Rate?
The interest rate is the cost of borrowing money from a lender, expressed as a percentage of the loan amount.
This rate determines how much interest you’ll pay over time and has a direct impact on your monthly mortgage payment. Because of this, many borrowers naturally focus on the interest rate first when evaluating loan options.
However, the interest rate doesn’t tell the whole story.
What Is APR?
APR, or Annual Percentage Rate, is designed to provide a more complete picture of a loan’s cost.
In addition to the interest rate, APR includes certain fees and charges associated with obtaining the loan. Depending on the loan program, APR may include:
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- Origination fees
- Mortgage broker fees
- Discount points paid to reduce the interest rate
- Mortgage insurance (when applicable)
- Certain lender-required closing costs
Because APR includes certain fees and charges associated with obtaining the loan, it will always be equal to or higher than the interest rate.
Generally speaking, a larger gap between the interest rate and APR indicates that more borrowing costs are being built into the loan.
By accounting for both interest and many of the costs required to obtain the loan, APR provides a more complete picture of a loan’s overall cost. This makes it one of the most useful tools for comparing competing financing options on an “apples-to-apples” basis.
How Real Estate Investors Should Use APR
APR can be extremely helpful when comparing financing options, but it’s important to understand one key limitation.
APR spreads certain upfront borrowing costs across the scheduled life of the loan. Because of this, APR becomes most useful when you expect to keep the loan for a long period of time.
For example, if Lender A offers a loan with a 7.00% APR and Lender B offers the same length loan with a 6.90% APR, Lender B would typically be the lower-cost option if you expect to hold the loan for its full duration.
However, many real estate investors don’t keep loans for the full term.
They may refinance after a renovation, execute a BRRRR strategy, sell the property after appreciation, or simply reposition their portfolio as opportunities arise.
This is where APR can become less useful as a standalone decision-making tool.
A Real-World Example
Imagine you’re purchasing a property using the BRRRR strategy and expect to refinance within 12 months.
One lender offers a loan with a lower APR but charges higher upfront fees and points. Another lender offers a slightly higher APR with lower upfront costs.
At first glance, the loan with the lower APR may appear to be the better deal. However, if you refinance the property a year later, you may not stay in the loan long enough for those higher upfront costs to pay for themselves.
In that situation, the loan with the higher APR could actually result in a lower total borrowing cost.
The lesson isn’t that APR is flawed. In fact, APR remains one of the best tools available for comparing loan options. The key is understanding what APR is designed to measure.
For investors with shorter time horizons, understanding the break-even point on upfront costs can be just as important as comparing APRs.
I discuss this concept in greater detail in my article, Should You Pay Mortgage Points on an Investment Property?
Frequently Asked Questions About APR
What is the difference between an interest rate and APR?
The interest rate is the cost of borrowing money, expressed as a percentage of the loan amount. APR (Annual Percentage Rate) includes the interest rate plus certain fees and costs associated with obtaining the loan, such as origination fees, discount points, and mortgage insurance when applicable. Because APR accounts for more than just interest, it generally provides a more complete picture of a loan’s overall cost.
Does a lower APR always mean a better loan?
Not necessarily. APR is an excellent tool for comparing loan offers, but it assumes certain borrowing costs are spread over the life of the loan. If you plan to refinance or sell a property before those upfront costs have paid for themselves, a loan with a slightly higher APR and lower upfront costs could potentially be the less expensive option.
Should real estate investors focus on APR?
APR should be one of the factors investors consider when evaluating financing options, but it shouldn’t be the only factor. Your investment strategy, expected holding period, available cash, and long-term goals all play an important role. For long-term buy-and-hold investors, APR can be particularly useful. For investors planning to refinance or sell within a few years, understanding the break-even point on upfront costs may be equally important.
Final Thoughts
APR is a valuable tool because it helps borrowers compare the overall cost of competing loan offers. However, it should not be viewed in isolation.
For long-term buy-and-hold investors, APR can be an excellent way to evaluate competing financing options and identify the loan with the lowest overall cost.
But a lower APR doesn’t automatically mean a lower-cost loan if you plan to sell or refinance before the upfront costs have paid for themselves.
Like most decisions in real estate investing, the best financing option depends on your strategy, expected holding period, available cash, and long-term goals.
The more you understand concepts like interest rates and APR, the better equipped you’ll be to evaluate loan offers, compare financing options, and choose the loan that best supports your investment plan.
Thanks for reading this week’s Experience, and best of luck in your real estate investing journey!
-BROCK