What Is APR on a Car Loan?
APR represents the total cost of borrowing money for a loan, including the interest rate and other fees, stated as an annual percentage. Find out the factors that affect the rate and how to determine if an APR is ‘good’.
Read time
5 minutes
Date
05.12.2023
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Inflation caused the Federal Reserve to raise the interest rate. This change can take a while before it's reflected in higher interest rates on cars, but it will in time as money is more expensive to borrow. But as inflation continues to rise, so will the Annual Percentage Rate (APR).
As you’re searching for a car, comprehending APR on a car loan can be critical for securing the optimal vehicle financing. Investigate the Annual Percentage Rate (APR) and how it affects your monthly payments, total borrowing cost, the differences between APR and interest rate, factors influencing your car loan's APR, and methods of calculating it.
What is an APR?
The APR represents the total cost of borrowing money for a loan, including the interest rate and other fees, stated as an annual percentage. Many confuse APR with the interest rate on their car loans. While both are related, they serve different purposes.
APR vs. interest rate
Interest rate is the percentage lenders charge for borrowing money. Meanwhile, the APR provides a more comprehensive view of how much you'll pay annually for your car loan.
As you’re in the process of buying a car, you may hear the term "buy rate". This is the interest rate figure the bank sells the interest rate for to the dealership. In some cases, if you get a loan directly from a car dealership, an interest rate markup is added so they can make a profit. The rate on your contract is the rate you negotiated on the deal. If there is a difference, the dealership considers that difference as profit. Knowing current interest rates from local lenders can help you negotiate your interest rates.
What factors affect APR on a car loan?
Understanding the factors that affect the APR you are offered can help you secure better terms and lower interest rates when borrowing money to purchase a vehicle. Here are some of the main aspects that lenders consider when determining your APR:
- Credit score - The higher you credit score, the better APR you may be offered. Read more about what credit score is needed to buy a car.
- Credit history - Lenders also examine your overall credit history before offering an APR for your car loan. This includes reviewing past delinquencies, bankruptcies, or other negative marks on your record.
- The amount financed - The total amount borrowed also affects the offered rate. Larger loans often come with higher interest rates due to increased lender exposure.
- The term of the loan - Longer-term loans typically have higher interest rates than shorter-term ones because they represent more extended periods during which the lender is at risk of not being repaid.
- Economic conditions - Lenders may adjust their offered APRs based on prevailing economic conditions and market trends, such as inflation or changes in the Federal Reserve policies affecting lending practices among financial institutions.
3 ways to find your car loan APR
When negotiating a car deal, the APR will be disclosed when you sign the paperwork. Check this figure and the total financed before you sign the loan agreement.
1. Review your loan agreement
The easiest way to find your car loan's APR is by reviewing your loan agreement or disclosure statement. This document should clearly state the interest rate, prepaid finance charges, and other fees associated with the loan, and if you're unsure, don't hesitate to contact your lender with questions.
2. Use online calculators
Suppose you haven't yet secured a car loan but want an estimate of potential APRs based on factors like credit score and the amount financed. There are several online calculators available where you can estimate your rate and payment to help you calculate APR.
3. Contact multiple lenders
When you shop around for the best APR, you can get an idea of the latest available rates. Don’t limit yourself to one type of lending institution. Consider credit unions, which are non-profits that often provide lower interest rates than traditional banks. Check several online lenders that specialize in car loans and can provide a quick quote, like LightStream or Upstart. And finally, ask banks that you currently bank with if they can offer you competitive rates.
What’s a ‘good’ APR?
A good APR can save you money and make your monthly payments more manageable, but how can you even know what ‘good’ means? Your credit score is one of the most important factors that’ll determine your rate. Typically, a higher score indicates less risk to a lender so you’ll be offered a lower interest rate. Here's an overview of typical credit score ranges and average interest rates:
- Poor credit (300 - 579) - Borrowers with poor credit may face higher interest rates ranging from 14% to over 20% due to increased risk for lenders. Your state will have a cap – a usury rate - on how much lenders can charge for bad credit loans.
- Fair credit (580 - 669) - Those with fair credit can expect slightly lower interest rates than those with poor credit but above average rates at around 11% to 15%.
- Good credit (670 -739) - Borrowers in this range will likely receive average or below-average interest rates between approximately 4% to 10%, depending on other factors such as income and debt-to-income ratio.
- Very good credit (740-799) - This group typically enjoys lower interest rates, between about 3% to 5%, which can result in significant savings over the life of a car loan.
- Exceptional credit (800+) - Borrowers with exceptional credit scores are often eligible for the lowest interest rates, usually between 2% to 3%.
How to lower your APR on a car loan
Here are some strategies for getting a better rate:
- Improve your credit score - Lenders often offer lower interest rates to borrowers with higher credit scores.
- Shop around with multiple lenders - Different lenders have different criteria for setting interest rates. You'll find the best rates by considering various offers. Just be selective on how the number of inquiries you make, as hard credit checks can affect your credit score.
- Negotiate with the dealer or lender - Don't hesitate to negotiate for better terms. Since some dealerships make money on financing, ask for a lower rate.
- Select shorter-term loans - While longer-term loans tend to come with smaller monthly payments due to spreading out the costs over time, they usually carry higher interest rates than shorter ones. You'll save money by borrowing money for three years instead of five years.
- Increase down payment amount - An increased down payment reduces the principal balance borrowed and prepaid finance charges associated with taking out a car loan. This will lead not only to lower monthly payments but also potentially help in securing reduced APR.
- Consider a co-signer - If you have poor credit, ask someone with better credit to co-sign your loan. If you do not pay back the loan, it falls on the co-signer to pay the debt.
An alternative to getting a car loan
If getting a car loan is not for you at the moment, or you’d prefer to work on building your credit to obtain a better APR, there are options in the meantime. You could lease, rent or consider a car subscription. With a car subscription, you can drive your car for 6-12 months and insurance, maintenance and roadside assistance are included in a monthly fee. If you need to change cars based on a lifestyle change or move, you can do so after your term ends. This allows for some flexibility as you build your credit.
