What Is APR Financing for Cars?
It would be difficult for most people to buy a new car if they had to pay cash up front. The ability to finance their purchase, that is, to put some money down and borrow the rest, allows consumers to spend their future earnings and keeps the economy growing. The cost of borrowing is the interest rate, but there's more to financing a purchase than just interest rates. Annual percentage rate, or APR, helps buyers assess the true cost of any given financing offer.
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Features
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Whereas the interest rate simply refers to the amount that must be repaid to the lender in addition to the principal, there are closing costs, financing fees and insurance requirements that go into a financing deal that affect the real expense to the buyer. APR incorporates all these expenses and gives the potential borrower a flat rate, including these hidden charges.
Function
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Federal law requires lenders to provide an APR figure so consumers can shop around. Borrowing money to buy a car can be complicated, involving various down payments, monthly payments and repayment periods on top of charges that can vary by lender. By simplifying all these expenses, Congress intended in the Truth-in-Lending Act to give borrowers a way to compare financing options.
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Significance
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Advertising low APR rates is a key marketing ploy for many car dealers. In reality, however, these low rates have historically been linked with somewhat severe restrictions. For example, advertised rates may be subject to a credit check, with all but the highest rated customers failing to qualify. Even among those with high credit scores, the advertised APR can be limited to 36 month leases, with those looking for a longer repayment period, and therefore a lower monthly payment, not qualifying.
Time Frame
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The time it takes to repay a loan turns out to be a key factor in the cost of borrowing. Money repaid quickly tends to come with a lower interest rate, since there is less investment risk for the lender. By 2006, U.S. car dealerships had begun increasing the repayment period of most auto loans without significantly increasing the interest rates, with the overall effect of lowering the APR. This, in turn, was a selling point to marginal buyers. In reality, the inability of buyers to meet the terms of more conventional lending terms was an early symptom of the economic deterioration that would manifest so poignantly just a few years later.
Considerations
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Even if the interest rate is not increased, and if APR goes down, extending the repayment period of a loan makes it much more expensive. Many financing experts recommend borrowers calculate APR for themselves and figure the total cost. Even if a sticker price looks attractive, the true cost of the vehicle includes the financing charges and interest. If these were considered prior to the purchase, buyers might make better purchasing decisions.
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