It would be great to borrow $20,000 for a car and simply repay the $20,000 and be done with it, but unless you borrow from a generous relative or close friend, it doesn't work that way. An auto loan includes interest on the principal balance, and often some additional fees as well.
The annual percentage rate (APR) is what you'll actually pay to finance the purchase of a vehicle. It's the yearly cost of your interest rate. You can find out what yours is the easy way: Simply ask your lender. The Truth in Lending Act, a federal law, requires that all lenders provide this information before someone commits to a loan agreement. Alternatively, you can grab a calculator and figure it out the good old-fashioned way if you're good at math and would rather not take someone else's word for it.
The APR on your loan tells you how much it's going to cost you to borrow money to buy a car.
Interest Rate vs. APR
Many consumers believe that their interest rate and their APR are the same thing, but this isn't the case.
Your interest rate applies only to the portion of your loan that represents what you're paying for the car itself. Your APR tells you what it's going to cost you overall to borrow the money, including fees added on to the purchase price and interest that starts getting tacked on even before your first payment is due.
It should come as no surprise then that your APR is almost always higher than your interest rate.
Calculating APR for a Car
You'll need to know the amount you're financing, any additional fees you must pay, your interest rate and the loan term before you start.
First, calculate the total interest you'll pay over the life of the loan based on your interest rate, and then add to this any additional fees associated with the loan. Now divide this number by your loan amount. Divide this number by the number of days in your loan term and multiply the result by 365 to find your annual rate. Finally, multiply by 100 to get the annual rate as a percentage.
Example of a Calculation
Let's say you're paying $20,000 for the car and you're putting down $2,000. Your loan balance is $18,000, and you're paying a 4-percent interest rate. That comes out to total interest of about $1,500. Additional fees add up to another $1,500. Now you're at $3,000
Divide that $3,000 by your loan amount, or $18,000. This works out to .1666. Divide this by 1,440 for a four-year loan: 48 months times 30 days in a month equals 1,440. This results in a figure of .000115. Multiply this number by 365 days in a year, then by 100 to get your APR of 4.22 percent.
This is the easiest way to calculate APR. You could also use a spreadsheet if you really want to roll your shirtsleeves up and do some work, or use one of the calculators found on the internet. You can also just look on your proposed loan contract if you don't want to do much work at all.
Why APR Matters
The APR is a critical number when you're shopping for an auto loan – more important than your interest rate – because it's the more accurate reflection of how much you're actually paying to finance the vehicle.
The Consumer Financial Protection Bureau recommends looking at this number instead of just your interest rate. It can come in particularly handy when you're comparing loan offers. Even just one percentage point can add up pretty significantly over a matter of years.