Interest Rate in Car Loans

APR vs. Interest Rate Car Loans: What To Know

With the economy unstable and car prices skyrocketing, affording the car you want will likely mean financing it. Sure, you could always lease a car instead of buying one, but leasing isn’t always less expensive—especially if you have bad credit. Good credit or bad, there are a few things you need to know about the finance process—specifically, APR vs. interest rate of a car loan.

According to Experian, 85% of new cars and trucks and 55% of used ones are purchased with financing. But how many of those car buyers knew the details of their car loan before they drove away? Because the finance process is a bit more involved than simply taking out a loan, you should understand the basics before you sign.

Here’s a quick rundown of what you need to know. The principal is the amount borrowed to buy the car, and the rest is interest and fees. The total is your monthly payment for the number of months you finance, and then you own the vehicle. Pretty simple, huh?

Yes and no. That’s because there are two interest rates on most car loans! While the math of trading in your old car to reduce the principal is pretty straightforward, APR vs. interest rate on a car loan needs some explaining.

What is a Car Loan’s Interest Rate?

The interest rate on a new or used car loan determines the percentage of the principal amount you pay each month. The interest is calculated on the principal balance when your payment is due, and a lower interest rate means you’ll pay less over the life of the loan.

Here’s how it works: If you buy a 20,000 car with a 7% interest rate on a 60-month term, your total cost will be $23,761. So you’ll pay $3,761 in finance charges if you go full term. For the same amount and same terms at 4% interest, you would only pay $2,100 in finance charges.

Because the interest on a car loan is categorized as simple interest, the longer you make payments, the less interest you’ll pay. That’s because simple interest financing means the interest is calculated based on your principal loan balance when your car payment is due.

The amount of interest you pay each month changes because you are also paying down the principal. A used car loan interest rate vs. the APR represents the cost per year of borrowing money for a car, not including fees and accruals.

What is a Car Loan’s APR?

APR is higher than the simple interest rate because it includes fees, interest accrued before your initial payment, and other charges. Simply put, the APR rate represents the total cost of financing a used car over the life of the loan. Like with simple interest, the lower the APR rate, the lower your overall cost to finance the car.

An APR applies to all parts of a car loan that involve charges and payments, so it’s important to know not only the APR but also the seemingly insignificant charges and fees included. Of course, you’ll pay interest on the principal, but you may also be paying interest on sales tax, extended warranties, registration fees, and other charges.

While understanding what you’re really paying for is critical, it’s assuring to know that the Federal Truth-in-Lending Act (TILA) has your back. The law requires all new and used car dealerships to provide buyers with a car loan’s APR.

APR vs. Interest Rate: Which Matters Most for a Car Loan?

When you’re reading over your car loan document, take time to evaluate the interest rate and the APR. Remember: the interest rate tells you how much it will cost you to borrow the money and is part of the APR. The APR will include the interest rate, fees, additional charges, and other costs. Because these costs will vary from dealership to dealership, the APR matters the most for determining how much your car will cost you over the term of the loan.

Be aware that typical APR vs. interest rates should only have a difference of no more than 25%. If you want to make the most of your car-buying budget, keep these three rules in mind: buy a reliable used car from a reputable dealer, put down as much of a down payment as possible, and understand how your interest rate and APR affects your total cost.

Now that you know the difference of APR vs. interest rate in a car loan, check out Car Time Supercenter’s pre-owned inventory. Stop by the lot here in Tucson, Arizona, and pick out some favorites for a test drive to find the car you love at a price you can afford.