You’ve probably heard the term APR tossed around a lot. But what does APR stand for, and what is the difference between interest rate and APR? While these terms are similar, they are not exactly the same.
APR stands for annual percentage rate.
Your APR is the total cost you pay per year for borrowing money in a loan. It includes your interest rate, but also any other fees and markups. That’s why it’s important to know your interest rate and your APR when you’re thinking about taking out a loan or refinancing.
In this guide, you’ll learn everything you need to know about interest rates, APRs, and how they are calculated.
The difference between interest rate and APR
How to calculate APR on a loan
How car loan interest rates are determined
How to get a lower APR on your car loan
Interest rate and APR are often used interchangeably in the car loan industry, but they are not exactly the same thing. An auto loan’s interest rate is the cost of borrowing money every year, expressed as a percentage. It does not include any fees that are charged for the loan. An auto loan’s APR (Annual Percentage Rate) is the cost of borrowing money every year, expressed as a percentage, including any associated fees.
So while they are similar, they are not exactly the same. The APR is considered to be a more accurate measure of the cost of the loan, as it takes all of the fees into account as well. The Truth in Lending Act requires lenders to disclose all loan terms and fees, so they are obligated to alert you to anything that you are responsible for paying. Since all lenders must disclose the APR, it is a valuable tool for comparing loan terms.
Note: Be sure that you are always comparing APR to APR, not APR to interest rate. You always want to compare apples to apples.
A car loan APR is calculated using the interest rate that you are offered. Here are the basic steps to calculate APR on car loans.
Determine the interest amount
Add any administrative fees to the interest amount
Divide by the principal
Divide by the number of days in the loan term
Multiply by 365 (one year)
Multiply by 100 to convert to a percentage
In other words, here is the APR formula:
APR = ((Interest + Fees / Loan amount) / Number of days in loan term)) x 365 x 100
Let’s put this to use. Math class is in session!
For example, say you are borrowing $20,000 to finance your new car. You have a 5% interest rate and a four year loan period. The closing costs on your loan are $700.
Principal (P) : $20,000
Interest Rate (R) : 5%
Time (T) : 4 years
The interest on the loan can be found with the formula:
Total Amount Accrued = Principal (1+Rate x Time)
Total Amount Accrued = 20,000 (1+.05 x 4)
Total Amount Accrued = 20,000 (1.2)
Total Amount Accrued = $24,000
So now we know our total amount accrued is $24,000, and our accrued interest $4,000 (Total Amount- Principal Amount). Now we can put all of this in our APR formula.
APR = ((Interest + Fees) / Loan amount) / Number of days in loan term)) x 365 x 100
APR= ((4000 + 700)/20000) / 1460 x 365 x100
APR = 5.875 %
So while your interest rate is 5%, your APR is actually 5.875%. This number more accurately represents the actual annual cost of your car loan.
While the car loan APR is what you should be comparing, this number is based on the interest rate that you are offered. But how are car loan interest rates determined? Why do these rates vary from person to person?
Car loan interest rates are determined by:
Market factors
Your credit
Your income
Your loan term
Car loan interest rates depend in part on how the economy is performing. Interest rates are set by the Federal Open Market Committee (FOMC). If the committee determines that spending needs to be encouraged, it will lower interest rates to do so. Conversely, if inflation is high, they might raise market interest rates to slow things down.
Read our guide to how interest rates are determined for a more in-depth look at how this works and why it might be relevant to your financing or refinancing options.
Your credit score is the most important factor in your car loan interest rate. Credit scores are the biggest variable from application to application.
Your credit score takes into account the following categories:
Payment History. Do you have a history of on time payments? Have you missed payments in the past? Lenders want to be sure you will pay back your debt on time.
Amounts Owed. How much money do you owe? The amount of money you owe, your debts, are used to calculate your credit utilization rate. A credit utilization score below 30% is considered desirable for lenders.
Credit History Length. How old are your accounts? Having older accounts and a longer credit history is more favorable to lenders.
Credit Mix. Do you have a mix of different types of accounts and debts? A good mix might include a mortgage, auto loan, student loan, and credit cards. This indicates to lenders that you can manage your money across multiple accounts.
New Credit. Do you have a lot of hard inquiries on your credit? Do you have some brand new debts? These might be considered liabilities by lenders.
In addition to your credit score, lenders will also look at your income and your debt-to-income ratio. If you are carrying too much debt, the lenders may only offer higher car loan interest rates as they consider you to be a riskier candidate.
In general, the longer the loan term is, the higher the interest rate you are offered will be.
Lenders will offer lower rates for shorter terms. This means that if you select a longer lease period, you are not only paying a higher car loan interest rate, but you are paying it for a longer period of time. This means you will end up paying a lot more money overall by selecting a long repayment period.
On the other hand, if money is tight, choosing a longer loan term can mean a lower monthly payment, which may be the right choice in certain circumstances (for example, if you need a car for work and can’t afford a higher payment), despite the downside of more interest paid over the life of the loan.
If you are looking to secure a new car loan or refinance an existing loan, you’ll likely want to find the lowest APR car loan you’re eligible for.
Here are a few actions you can take to increase your chance of securing a good car loan interest rate:
Get your credit report and review for errors
Request higher credit limits
Keep your credit balances below 30%
Make on time payments
Shop around and compare
Contact one of the major credit bureaus (Equifax, Experian, and TransUnion) to get a free copy of your credit report.
You can get your report from each agency for free once per year. Review your report carefully and look for any inconsistencies. Are the dates of opened accounts correct? Are the balances on each account accurate? Is your payment history correct? Make sure that all credit limits are up to date and that all personal information is accurate. If you notice any errors, report them immediately.
The higher your credit limits are, the lower your credit utilization ratio will be.
This ratio looks at the amount of money you owe and the amount of money available to you. Lenders will often increase your limits throughout the years when they review your information, but you can also try requesting a higher limit. This will help your score as soon as it is reported to the credit agencies.
Keeping your balances to less than 30% of your available credit will help your credit score greatly.
This will lower your credit utilization ratio, as discussed above. Those with the highest credit scores often use less than 7% of their available credit, so keep that in mind when you are looking at your accounts. Working to keep a low credit utilization ratio will help your score immensely, and with it your eligibility for a low APR.
Making consistent, full, and on time payments will help your score a lot. Sign up for autopay if you are able to, or set an alert on your calendar if you have a tendency to miss payments.
The car loan interest rates that you are offered will vary greatly from lender to lender, so you really want to prioritize shopping around. Remember that you can and should negotiate on the interest rate and fees you’re offered, especially if you’re considered dealership financing.
If you are looking to refinance, Auto Approve makes shopping around and comparing incredibly easy. We have relationships with 50+ trusted lenders all across the country and can easily help you apply and compare offers instantly.
Now that you know all about car loan interest rates and annual percentage rates, or APRs, you’re ready to go out and get your best loan or refinance—and if you’re refinancing, Auto Approve is here to help.
If you’re ready to refinance an auto loan, get your free, no-commitment quote today.
