Understanding How APR Works

The term APR stands for Annual Percentage Rate. If you get a car loan for a period of years, APR is a measure of the total amount of interest you will pay on your financing, over a one year term. When APR is calculated, it has to include both the cost of the borrowing and any associated fees that are automatically included. Thus it’s meant to give you the overall equivalent cost of a debt. When you receive an interest rate quote from your lender, it may be expressed in interest rate per term. This does not tell you how much interest you will pay per year in annual percentage rate (APR).

APR has no fixed form and its amount can vary from lender to lender. The very fact that different companies can offer different rates of APR indicates that there is some fluidity in its’ structure. As a general rule of thumb, the lower the APR the better the lending deal is for you, so when it comes to committing your monthly payments to a lending company it is in your best interests to shop around for a good deal.

Where one company appears to be offering a smaller APR and thus a better deal on what appears to be the same offer, it is prudent to ask; where will they recoup those ‘losses’. Due to its huge influence in any financial agreement the law stipulates that all lenders have to tell you what their APR is before you sign any agreement.

The Difference between Interest and APR

It is important to understand that the interest rate you see in an advertisement is not what you will be paying to finance your new car, truck, SUV or minivan. Your APR rate amount should legally represent the entire, complete “true cost of the loan” over the time you owe the lender money. Your interest rate is usually the percentage you owe each month based on each $1,000 you borrowed.

This is from the regulator, the Financial Conduct Authority (FCA):

“APR stands for the Annual Percentage Rate of charge. You can use it to compare different credit and loan offers. The APR takes into account not just the interest on the loan but also other charges you have to pay, for example, any arrangement fee. All lenders have to tell you what their APR is before you sign an agreement. It will vary from lender to lender.”

The fact it includes charges means sometimes the APR can be a bit confusing. It is possible the interest rate is 14% per annum, but the APR is 17%, as the impact of the charges adds the equivalent to another 3% interest. Yet this is useful as it allows a true comparison.

Knowing the difference between what is APR rate and interest rate and can be tricky because they are definitely not the same figure in your financial agreement. For example, if your lender offers a 3% interest, you should ask if this is interest or APR. With car loans, you only pay simple interest on the principal, so you can expect to pay 3% on each term for your total length of payment. If you have a 48 month car loan, for example, your APR will be 36% per year for 4 years. This is found using a basic formula:

  • APR = (interest rate per period) * (number of periods in a year)

In the example above, this means:

  • APR = (3%) * (12) = 36%

Once you have been able to locate a lender with the most attractive APR, you need to learn more about the offer so you can make an informed decision to commit to deal and it’s terms and agreements. One of the most important questions you’ll need to find out about is whether the APR is fixed or variable. If the APR is fixed then your monthly payments will remain the same if your credit balance remains the same for any length of time. This is where it is crucial to read the fine print.

If in the small print the agreement states that the APR is variable, then chances are that after an introductory period of 12.5% (for example), the rate will not only jump up to something like 17.5% but will also vary thereafter. Essentially, this means that once you have gone through the introductory period, you will now being charged the higher rate of 17.5%. From this point onwards, the rate may drop to something like, 15.6%, or increase further so you could see the rate hit 19.7% and then 22.7% and keep going up!

7 days ago

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