How APR Works on Auto Loans

When you finance a car, the annual percentage rate, or APR, is the number that tells you what borrowing will really cost. Two loans for the same car with the same monthly payment can cost very different amounts if their APRs differ, and a difference of a few percentage points can add up to thousands of dollars over a loan.

This guide explains what APR includes, how it differs from the interest rate, how lenders decide what APR to offer you, and how to use it to compare loans and get a better deal.

What APR means

APR is the yearly cost of borrowing, expressed as a percentage. Under the federal Truth in Lending Act, lenders must disclose the APR on consumer loans, so you can compare offers on a consistent basis.

The key point: APR includes the interest rate plus certain fees charged to get the loan, spread over the loan's term. That's why it's a better comparison tool than the interest rate alone.

APR vs interest rate

An example of fees raising the APR

Suppose you're offered a 60-month loan at a 7% interest rate, but the lender adds a $500 fee to the amount you borrow. You receive $25,000 toward the car, but you're borrowing $25,500.

• Your payment is about $505 a month.
• Over five years, you repay about $30,296.
• Measured against the $25,000 you actually received, the loan's APR is about 7.83%, not 7%.

Comparing APRs reveals that difference immediately, which is exactly why lenders are required to disclose it. Which fees are included in APR is set by federal rules, so ask each lender for a breakdown of all fees as well.

How much APR changes what you pay

Here's what a $25,000, 60-month loan costs at different APRs:

The difference between 5% and 16% is about $136 a month, and more than $8,000 over the loan, for the same car. These rates are examples to show the effect, not current market rates.

How lenders decide your APR

Lenders set APR based on how likely they think you are to repay, and on the loan itself:

• Your credit history and score. This usually has the biggest effect. Borrowers with strong credit typically qualify for much lower rates.
• The loan term. Longer loans often carry higher rates. See How Long Should a Car Loan Be?
• New or used car. Loans for used cars often have higher rates than loans for new cars.
• Your down payment. A larger down payment reduces the lender's risk and can help you qualify for better terms. See How Much Should You Put Down on a Car?
• Your income and existing debts, often measured as a debt-to-income ratio.
• The lender. Banks, credit unions, online lenders and dealership financing all price differently.
• Market interest rates, which rise and fall over time.

Dealer financing and rate markups

When you finance at a dealership, the dealer usually sends your application to one or more lenders. A lender may approve you at a certain rate, sometimes called the "buy rate," and the dealer may be allowed to offer you a higher rate and keep part of the difference as compensation. This is legal and common, and it's one reason to arrive with a preapproved offer: it gives you a benchmark, and you can ask the dealer to beat it.

Dealers also sometimes offer promotional financing from the manufacturer, such as very low or 0% APR on certain new models. These deals can be excellent, but they're usually reserved for buyers with strong credit, and they sometimes replace a cash rebate. Compare the total cost of taking the low rate versus taking the rebate with financing from another lender.

How to get a lower APR

1. Check your credit reports before you apply, and dispute any errors. You can get free reports from the three nationwide bureaus at AnnualCreditReport.com.
2. Get preapproved by a bank, credit union or online lender before visiting a dealer. See How to Get Preapproved for an Auto Loan.
3. Compare several lenders within a short period. Common credit scoring models typically treat multiple auto loan inquiries within a short window as a single inquiry for scoring purposes.
4. Choose a shorter term if the payment fits your budget.
5. Make a larger down payment.
6. Consider a co-signer with strong credit, understanding that they become fully responsible for the loan if you don't pay.
7. Negotiate. Ask the dealer to beat your preapproved rate, and negotiate the car's price separately from the financing.

How APR works month to month

Most auto loans are simple interest loans. Each month, interest is calculated on your remaining balance, and your payment covers that month's interest first, with the rest reducing the principal. As the balance falls, more of each payment goes toward principal. This means:

• Paying extra toward principal reduces future interest.
• Paying late can increase the interest you pay, as well as triggering late fees.
• Paying off early usually saves interest; check your contract for any prepayment terms first.

For more on how loans are structured, see How Auto Loans Work.

Fixed vs variable APR

Most auto loans have a fixed APR that doesn't change, so your payment stays the same for the whole loan. Some lenders offer variable rates, which can rise or fall with market rates. A fixed rate makes budgeting predictable; if you're offered a variable rate, ask how high it can go.

If your APR is high

If you've taken a loan with a high APR, for example because your credit was weaker at the time, you may be able to refinance later once your credit improves or market rates fall. See Refinancing a Car Loan: When It Makes Sense.

Reading your loan disclosure

Before you sign, the lender must give you a Truth in Lending disclosure. It usually includes a box with four key figures, and it's worth checking each one:

If the amount financed is higher than you expected, look for extras such as extended warranties, service contracts, paint protection or gap coverage that were added to the loan. These are usually optional, and you can ask for them to be removed.

Common APR mistakes

• Comparing monthly payments instead of APR. A lower payment can hide a higher rate over a longer term.
• Negotiating the payment instead of the price. It's easy to reach a target payment by extending the term or raising the rate, without lowering what you pay overall.
• Shopping lenders over several months, which can mean more separate credit inquiries.
• Skipping preapproval, leaving you without a benchmark at the dealership.
• Assuming promotional rates apply to you. Advertised low rates often require strong credit and specific models or terms.

APR on new and used cars

Loans for used cars often carry higher APRs than loans for new cars, partly because used cars have less predictable values and no manufacturer promotional financing. That doesn't mean new is always cheaper overall: a used car's lower price can more than make up for a higher rate. Compare the total cost of the specific cars you're considering, including interest, rather than the rate alone.

Putting it together

• APR includes the interest rate plus certain fees, so it's the best number for comparing loans.
• A few percentage points can change the total cost by thousands of dollars.
• Your credit, the term, the car's age and your down payment all affect the APR you're offered.
• Get preapproved, compare lenders within a short window, and ask the dealer to beat your best offer.

To see how different APRs change your payment and total interest, try our Car Loan Calculator.