Financing a car can be confusing, even if you've done it before. There are a lot of acronyms and jargon to understand, and knowing exactly how much it will cost to finance a car can be difficult. In this article, we'll break down one of the common terms you'll see listed next to the interest rate when financing a vehicle: the APR.
The APR is the Annual Percentage Rate. It accounts for the interest rate, plus certain fees or charges associated with getting the loan, and it represents how much your borrowing costs will be each year of your vehicle loan.
The Difference Between APR and Interest Rate
The interest rate is the cost, expressed as a percentage rate, that your lender will charge you to finance your vehicle. Unlike APR, the interest rate does not reflect certain fees or other charges that may be assessed on the loan.
Under the Truth in Lending Act, lenders are required to disclose the interest rate and the APR for your loan. This is so you can accurately compare your total finance costs against multiple products and across multiple lenders. A loan with a low interest rate might seem attractive, but high fees might increase your cost of borrowing. The APR will help you get a true sense of your costs over time.
The APR is almost always higher than your interest rate. If there are no additional costs or fees for establishing the loan, the APR and interest rate may be equal.
If two loans have the same interest rate, but a different APR, the one with the lower APR probably has lower fees. Be sure to always understand the fees and other charges associated with any loan you are considering.
Why Is It Important to Understand APR?
APR matters because it reflects the true cost of financing and can be utilized to compare loans.
As mentioned, the APR includes certain fees and charges. Auto loans often come with fees. These fees may include the following:
- Loan application and processing fee (also known as "establishment fee")
- Prepaid interest, which is the interest calculated between the time the loan is funded and the first payment date
- Administrative and document preparation fees
It can be hard to manually calculate the costs of all these fees and your interest rate , which is why the APR is a useful tool when shopping for a loan since the APR takes these into account.
Factors The APR Doesn't Account For
It's important to note that an APR doesn't take into consideration certain costs. For example, the APR doesn’t take into account the compounding effect of interest (when compounding interest is applicable). The actual interest paid over the course of the loan will be less than simple interest calculations will tell you because, in most car loans, you pay less interest as you pay the loan down.
Other car buying costs that are not accounted for in the APR include registration fees and insurance that aren't amortized in your car loan.
Compare Apples To Apples With The APR
When you're planning to purchase a vehicle, make sure you're comparing apples to apples when exploring your financing options. The APR converts the cost of borrowing to pay for a car into one rate, which you can cross-shop against different lenders. A lower interest rate might sound enticing, but it might not always be the least expensive loan during the repayment term. Understanding the full cost of a loan is important when exploring your borrowing options. The APR helps make that easier to determine.
Learn more about vehicle finance options and calculate your monthly payments here.