How Does APR on a Car Loan Work?

APR stands for annual percentage rate. The APR on a car loan is the interest rate of the loan. The APR is one of the factors that determines the amount of a car payment and is a factor that a buyer has significant control over. The APR a buyer receives on a car loan is based on several factors.

Function

The payments on a car loan are calculated with each payment comprised of part interest and part principal repayment. The amount of interest is higher for early payments because the interest amount is based on the amount of principal outstanding. Each payment has less interest and more principal paid than the previous one. A higher APR requires that more interest be paid resulting in a higher monthly payment.

Significance

The effect of different interest rates or APRs can be dramatic. A $20,000 car loan with a 7 percent rate and 60 month term would have a monthly payment of $396. If the car buyer can only qualify for a 12 percent loan, the payment would jump up to $445 per month. The loan with the higher APR will pay almost $3,000 more in interest over the term of the loan.

Considerations

The most important factor in what APR a car buyer qualifies for is the buyer's credit history and credit score. Buyers with good credit will qualify for the lowest APR and have several financing options to choose from. Car buyer with bad credit will pay a higher APR and will have limited choices for terms and payments.

Factors

There are several factors that affect the APR on a car loan. Longer term loans will have a higher APR than short term loans. New cars will qualify for lower rates than used car loans. Buyers who put down a cash down payment will usually qualify for a lower APR than buyers with no down payment. Promotional rates from car manufacturers will be lower than the rates offered by banks and credit unions.

Potential

Unless the car loan APR is a promotional rate or the buyer has very bad credit, most APR offers from car dealers are negotiable. Dealers get the rates from the lender at a wholesale APR and then add to the rate to earn additional profit. Always negotiate with the dealer finance department for a lower APR on the car loan. Saving one-half or one percent on the interest is like saving several hundred dollars on the price of the car.