When you apply for a car loan, you’ll receive a quote from the lender. It will include the loan amount, term, and projected monthly payment based on these figures. You’ll also notice the annual percentage rate (APR), which should not be overlooked as it could easily add several hundred or thousands of dollars to the vehicle’s total purchase price.
What is APR (Annual Percentage Rate)?
The APR you pay on an auto loan represents the cost of borrowing funds from the lender.
Is APR the Same as the Interest Rate?
Consumers often use the terms interest rate and APR synonymously, but they aren’t quite the same. The interest rate is the percentage of the principal amount the lender charges you to borrow funds. However, the APR includes interest and fees, like loan origination costs you’ll pay when financing the vehicle.
Why the APR Is Important for a Car Loan
The APR is important because it tacks on a sizable amount of additional costs to the loan. So, shopping around for an auto loan is essential to ensure you get the best deal possible on financing.
APR and Your Credit Score
The lowest APRs are generally reserved for borrowers with good or excellent credit. Of course, a bad credit score doesn’t necessarily mean you’ll be denied an auto loan. Still, you can expect borrowing costs to be higher.
To illustrate, a 60-month $30,000 auto loan with a 5 percent interest rate comes with a $566 monthly payment, and you’ll pay $3,968 in interest over the loan term. But if your credit score is on the lower end and you get a 9 percent interest rate, the monthly payment will increase to $623, and you’ll pay $7,365 in interest over the life of the loan.
Defining Key Concepts and Terms
You’ll need to familiarize yourself with these terms to compute the APR on an auto loan.
Principal Loan Amount
It is the total amount of money you borrow from the lender to fund the purchase of the vehicle.
Interest Rate
It is the percentage of the total loan amount the lender charges you to borrow money and can be fixed or variable. Car loans generally come with fixed interest rates.
Loan Term
It represents the repayment period or the number of months you’ll make installment payments to repay the amount you borrow. Most auto loans feature loan terms between 36 and 72 months.
Fees and Additional Costs
You could incur other auto-loan-related expenses. These often include origination fees, documentation fees and other administrative costs.
Calculating APR on a Car Loan
Follow these steps to calculate the APR on an auto loan with ease.
Get Information on Your Car
You’ll need to prepare the following details to get started:
- Principal $35,000
- Interest Rate: 6 percent
- Loan Term: 48 months
- Projected interest: $2,200
- Fees: $1,500
- Taxes: $3,000
Once you have these figures, plug them into the APR equation below.
Plug Them into the APR Equation
- APR = [(Interest, taxes and fees / principal / loan term in days) * 365] * 100
- APR = [($6,700/$35,000/1,460) * 365] * 100
- APR = 4.79 percent
Or Use an Online APR Calculator
You can also input these figures into an APR calculator that will do the calculations for you.
Common Mistakes When Calculating APR
Borrowers often make the mistake of overlooking certain fees, misinterpreting key terms or ignoring the impact of the loan term.
Overlooking Additional Fees
As previously mentioned, car loans often come with hidden fees that are easily overlooked. They could increase your overall borrowing costs significantly, so it’s worth factoring them in to get a more accurate idea of what to expect.
Confusing APR with Interest Rate
It’s easy to confuse the APR with the interest rate, but these are distinct terms. The interest rate only refers to the cost of borrowing the principal amount. However, APR includes both the interest rate and other fees associated with the loan.
Not Considering Loan Term
The loan term significantly impacts APR. A longer term usually results in paying more interest over time, affecting your APR. However, a shorter term could equal much lower borrowing costs despite much steeper monthly payments.
How Lenders Calculate APR
Most lenders assess your APR based on your credit rating, assuming you meet the other eligibility criteria. As mentioned above, with a higher credit score, you’re more likely to receive a competitive APR. But if your credit score is on the lower end, expect to be offered a higher APR to offset the risk of defaulting on the auto loan that you pose to the lender.
Other factors lenders consider when calculating APR include:
- Principal: The loan principal or the amount you’re requesting to borrow
- Down payment: You may not be required to make a down payment. However, doing so could get you a lower APR on your auto loan
- Loan term: You’ll pay more in interest if you opt for an extended loan term, which could overshadow the benefit of securing a more affordable monthly payment
What is a Good APR for a Car Loan?
It depends on your credit rating. Borrowers with good or excellent credit scores can expect to pay an APR between 3.61 percent and 5.38 percent. However, if your score is lower, you could get an APR from 9.8 percent to 19.87 percent.
Compare APR and Loans to Refinance Your Car Loan
If your credit score has already improved since you took out your original car loan, you could qualify for a lower APR by refinancing. Here’s how to get started:
- Step 1: Submit your details to get pre-approved. Be prepared to answer a few questions to verify your identity. You’ll also need to input data about your employment, earnings and vehicle.
- Step 2: View your loan offers. If there’s a match that works for you, upload the requested financial documents and information. You’ll need to provide a copy of your driver’s license, current proof of insurance, a current registration, proof of income (or pay stubs) and your current auto loan contract if you have it available. The lender will handle all the paperwork for you and ensure you steer clear of all the tedious tasks that often come with refinancing auto loans.
- Step 3: Sign your loan documents. Once the loan is finalized, you’ll start paying the new lender, typically within 45 days. However, you may qualify for a 90-day payment deferral that lets you keep more of your hard-earned money in your pocket even longer.
Tips for Getting the Best APR on a Car Loan
To get the best APR on an auto loan, pay attention to your credit score, compare rates, negotiate fees and be sure to choose a reliable lender.
Improve Your Credit Score
Your credit score is a vital factor in determining your APR, as lenders use it to assess the risk of default when lending you money. A higher credit score indicates lower risk, often resulting in a more favorable APR.
To improve your credit score, pay bills on time, reduce revolving debt balances (i.e., credit cards, personal lines of credit) and monitor your credit report for errors. While this process may take time, the potential cost-savings on interest over the life of the loan make it worthwhile.
Shop Around for Rates
Not all lenders are the same, and some are known to offer better deals on auto financing than others. So, it’s worth shopping around for a bit to find the lowest rates. Explore what banks, credit unions and online lenders have to offer.
Get prequalified with at least three lenders and compare loan quotes to determine which offers the most competitive APRs and loan terms.
Negotiate Terms and Fees
Don’t be afraid to negotiate with the lenders you’re considering. More often than not, APRs, terms and fees aren’t set in stone, so it’s worth asking to see if you can get a better deal.
Use other loan quotes as leverage, and communicate your intention to move on if they aren’t willing to budge. You can also ask about more competitive loan terms if you opt for a shorter repayment period.
Go With a Trusted and Reliable Lender
You want a lender that’s both reliable and trustworthy to ensure your experience is practically seamless. Check out reviews from past and current customers to get a feel for the level of service provided by the lender. Keep in mind that you may see a review from a disgruntled customer here and there. That said, negative reviews shouldn’t be a pattern, as that’s a tell-tale sign of a bigger issue.
Conclusion: The Importance of Accurate APR Calculation
Ultimately, understanding how to calculate your car loan’s APR is vital, as it helps you understand the true cost of your loan. When you accurately calculate the APRY, you’ll be better prepared for your monthly payments, saving you time and stress in the long run.
