If you’re considering taking out a car loan or refinancing, it’s very important to know the difference between an APR and an interest rate and be able to compare them. Once you know the difference between an APR vs. interest rate, you can make an informed financial decision that makes sense for you and your family.
First, it’s essential to know the definitions of the terms APR and interest rate.
- APR: APR stands for annual percentage rate. It is generally expressed as a percentage, and it is the annual cost of borrowing money. APRs are not limited to just car loans, either. You’ll come across APRs for credit cards, mortgages, student loans, investments, and loans. An annual percentage rate or APR is the cost of the loan to you, the borrower. An APR can include fees like insurance, closing costs, loan initiation costs, and other fees. While you may think that APR and interest rate are the same, they are not.
- Interest rate: An interest rate, on the other hand, is the annual cost of borrowing money. It is also expressed as a percentage. The interest rate does not include the additional fees that are included in an APR.
According to Investopedia, an APR should always be greater than or equal to, an advertised interest rate. If you’re comparing two loans, side-by-side, the lender offering the lower advertised or nominal rate, usually offers the best value.
Why does APR vs. interest rate matter?
You can use both the interest rate and APR to find out how much borrowing money will cost you. Both numbers offer a way for you to comparison shop between loan offers and determine how affordable the loans might be for you. By comparing APRs or interest rates, you can determine what the best deal might be for your financial situation. In many cases when you are shopping for a car, an auto loan will include both an interest rate and an APR. These two numbers will tell you the cost of borrowing money to finance your new or new-to-you car.
What is an APR on an auto loan?
An APR on an auto loan is a percentage that expresses the total cost (including fees) of the loan. The higher the APR, the more you will pay for the auto loan. Lenders are required to provide an APR, thanks in large part to the Truth in Lending Act (TILA). This act requires that lenders provide borrowers written disclosures about the terms of a loan or line of credit. This disclosure will include a few critical things, including:
- APR or annual percentage rate
- Finance Charges: The cost of interest and fees over the life of the loan usually expressed as a dollar amount.
- Amount Financed: The total dollar amount of the loan or credit you are borrowing.
- Total of Payments: The sum of all the payments you’ll make at the end of the loan if you decide to move forward with that particular lender.
Thanks to the requirements of TILA, you can use the APR on an auto loan to comparison shop two different loan offers.
How is an APR calculated?
An APR on an auto loan is the interest rate plus any additional fees. If a lender gives you the interest rate, you can figure out the APR with a few more pieces of crucial information. First, you need to gather all the fees, interest, and principal numbers. The principle is the amount of the loan. Once you have those numbers, you can use the following formula from Investopedia to figure out the APR. APRs change based on what your credit looks like. If you have bad credit, you will likely end up having to pay a higher APR and interest rate. If you have good credit, then you will likely get a much lower APR and interest rate. You can find an APR on everything from credit cards and mortgages to checking and savings accounts, personal loans and student loans. An APR is sort of the jack-of-all-trades number that tells you what you’ll need to lay out to pay down the balance of a loan you take out.
How can you get a lower APR on an auto loan?
Getting a lower APR means that you will pay less for the auto loan. You can get a lower APR on an auto loan by doing a few things. They include:
- Improve your credit score: The better your credit, the lower the APR you can get.
- Negotiate the APR with the lender: While it may seem like you can’t negotiate the APR that a lender gives you, you can! To negotiate your APR shop around and find other companies that offer lower rates. Once you have those competitive offers in hand, you can use them to negotiate for a lower APR.
- Negotiate the cost of the car with the dealer: The lower the price of the vehicle, the less you’ll need to borrow, and the lower your APR will be.
- Apply with a co-borrower or co-signer: Some loans allow for co-signers or co-borrowers to help make the credit application stronger. Check with your lender to see if they allow for co-signers or co-borrowers on your auto loan.
- Shorten the length of the loan: If you can afford to shorten the length of the loan, you will end up paying a lower APR. In many cases, however, this will mean that your monthly payments are going to be higher.
What is an interest rate on an auto loan?
An interest rate on an auto loan is the amount you will pay each year to borrow money from a lender. An interest rate does not include additional fees like the cost of initiating the loan or any added fees. It is different from the APR in that way. The current average interest rate for a 60-month (or 5-year) auto loan is around 4.6% according to Bankrate. Rates go up and down based on a variety of both macro and micro-economic factors, including whether the U.S. Federal Reserve is raising or lowering rates, inflation, and other factors. Your credit worthiness or credit score also determines what kind of interest rate you could be eligible for on an auto loan.
How can you get a lower interest rate on an auto loan?
To get a lower interest rate on an auto loan, you should take the following steps:
- Ensure that you have excellent credit: Your credit score is used to determine how good of a borrower you are. Factors that go into your credit score include things like the length of your credit history, the number of accounts you have open, the type of credit lines you have, and how often you have paid your debts on time or late (or not at all).
- Clean up your credit report: Occasionally, some errors show up on a credit report. If, when you pull your credit report, you notice that there are errors on it, you should act immediately to correct them. It can take quite a bit of time and paperwork to sort out credit errors.
- Negotiate the price of the car: The less you have to borrow, the better your interest rate might be. It’s worth trying to get the price of the car as low as possible so that you can take out less money in the form of a loan.
- Shop around: It always pays to shop around—not only for vehicles but also for loans and interest rates. When you find a lender that offers a low rate, you can then begin to negotiate with the lender to see if you can get an even lower rate.
- Apply with a co-signer or co-borrower: If your credit is poor, it might make sense to apply for a loan with a more credit-worthy co-signer or co-borrower to lower your interest rate.
- Put more money down on the loan: The more money you put down on a purchase, the lower your APR will be. This is because the bank lending you the money will be taking on less risk because they won’t need to lend you as much. As a result, they can offer a lower APR.
What is the difference between an APR vs. interest rate on an auto loan?
An APR takes into account the total cost of the loan, including fees while an interest rate does not. The APR gives you more information about just how much a loan might cost you, while an interest rate only gives you an idea of one piece of the puzzle. You’ll still have to pay for fees and other charges. According to the Consumer Financial Protection Bureau, lenders and dealers are not required to offer you the best rates that are available. To save money over the life of the loan negotiate to get the lowest interest rate and APR that’s available to you.
How do you compare APR vs. Interest Rate?
To accurately compare rates and ensure that you are getting the best bang for your buck, you will need to compare APR vs. interest rate. To do so, its best to work with the APR for both loans, and compare them side by side. Since banks are required to give you the APR, thanks to the requirements of the Federal act called TILA (mentioned above), you can easily compare two loans side by side, provided that both loans have the same terms or length. APRs will change based on the length of the loan (since you’ll end up paying more interest the longer the duration of the loan is) so be sure that you are comparing the same parameters when looking to compare loans. You can compare interest rates, similarly but they are not as useful as APRs or annual percentage rates when comparing the cost of loans. This is because interest rates don’t take into account the total cost of the loan. They don’t take into account the fees and other associated costs of the loan. When comparing interest rates, you should always ensure that you are comparing two loans that both start with the same principle (or loan amount), and the same term (also known as the length of the loan). Again, the longer the loan, the lower the interest rate may be on paper—but that can be deceiving because you’ll be paying the loan back over a longer period of time. It’s highly likely that the longer loan term will actually cost you more in the long run. Before you even begin comparing loans however, it’s important to do some preliminary legwork. That means figuring out just how much you can afford to take out and whether a lease or a buy make better financial sense for your personal situation.
The Bottom Line
Comparing APR vs. interest rates might seem a bit tricky since there’s a vast difference between the two. It’s essential to understand the difference so that you can make an informed decision between two loans of any kind. By comparing APRs vs. interest rates, you can learn more about what the total cost of a loan might be and strengthen your financial future. Follow the tips above to compare APR vs. interest rates, and you’ll be well on your way to finding the right loan for you.