Interest rate, APR, and total borrowing cost
The note rate, APR, monthly payment, and total borrowing cost measure different features. Fees and repayment timing determine which loan costs less over the borrower’s actual holding period.
An annual percentage rate, or APR, is a standardized annualized borrowing-cost measure that incorporates interest and specified finance charges. The note rate determines contractual interest on principal; total borrowing cost measures the dollars paid in interest and charges over a specified repayment path.
Annualized price and total dollars are different measures
A loan’s principal, term, amortization, fees, and payment timing all affect its total cost. A lower annual rate applied over many more years can produce more interest in dollars.
Take two $100,000 loans with monthly payments, no fees, and no early repayment. A ten-year loan at 6% requires approximately $1,110.21 a month and $33,225 of total interest. A thirty-year loan at 5% requires approximately $536.82 a month and $93,256 of total interest.
The second loan has a lower rate and payment but a much longer period over which interest accrues. The lower payment is partly the result of slower principal repayment.
Upfront fees make the holding period matter
For a closed-end mortgage, a borrower can pay an upfront charge to obtain a lower note rate. Whether that exchange saves money depends on how long the lower rate applies before payoff.
Take a $100,000 thirty-year fixed-rate mortgage at 6% with no upfront finance charge. Compare it with the same principal and term at 5.5%, with a $3,000 charge paid separately at closing. Assume monthly payments, no other fees, and no prepayment penalty.
The payments are approximately $599.55 and $567.79. If both loans are paid off after 24 payments, interest plus the stated upfront charge is approximately $11,857 for the first loan and $13,857 for the second. The lower-rate loan costs about $2,000 more over that holding period.
If held to maturity, the corresponding interest-plus-fee totals are approximately $115,838 and $107,404. The longer holding period reverses the comparison.
These calculations include the remaining principal when evaluating early payoff. Comparing monthly payments alone would miss the different balances still owed.
APR uses specified assumptions and charge definitions
APR is useful because it annualizes covered financing charges rather than displaying the note rate alone. It does not predict the borrower’s actual refinancing date, future property expenses, or every contingent charge.
The charges included in APR depend on the product and jurisdiction. A US mortgage APR should not be treated as a universal definition covering every credit card, installment plan, or foreign mortgage.
A complete comparison separates financing from ownership costs
For a mortgage, principal and interest payments are distinct from property taxes, insurance, maintenance, and other housing expenses. An escrow payment can collect some of those expenses without turning them into interest.
Compare the same amount borrowed, identify charges paid in cash or financed, and specify the repayment date or scenario. The note rate, APR, required payment, and total cost then describe complementary parts of the same offer.
Questions
- Can a lower APR loan cost more in total?
- Yes. A longer repayment period can produce more total interest despite a lower annualized rate. Total dollars also depend on the amount borrowed and repayment behavior.
- Does a lower monthly payment mean cheaper borrowing?
- No. A lower payment can result from a longer term and slower principal repayment, increasing total interest.
- Are mortgage taxes and insurance included in the note rate?
- No. The note rate prices interest on the outstanding principal. Taxes and insurance are separate costs, even when collected with the monthly mortgage payment.