How Does APR on a Car Loan Work?

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The APR, or annual percentage rate, on a car loan determines the interest rate you will pay for one year, as opposed to monthly rates. Knowing the annual rate makes it easier to shop around for a better deal among various lenders, but understanding exactly how your personal rate is calculated can be a bit more complicated.

Average APR

At the time of publication, the average APR for car loans is around 4.38 percent for a 60-month lease and 5.2 percent for a 36-month lease, according to Bankrate, but you will most likely receive a different offer -- better or worse -- depending on your monthly income, credit history, who your lender is, brand of car and many other variables. This percentage rate is quite low compared to recent history; in 2010, you would have paid almost double, and if you go 20 years further back, you might have paid nearly triple.

Lowering the Cost

  • **Improve your [credit score](http://www.carsdirect.com/auto-loans/what-credit-score-do-you-need-for-an-auto-loan)**. The lenders who you are asking to finance your car will look at your credit history as one of the main factors in determining what interest rate they will give you. The difference in interest rate between the best and worst credit scores is about 10 percent, which will really add up over the course of the loan.
  • **Get a shorter-term loan**. A long-term loan, such as 72 months, means you will almost always have lower payments, because the loan is spread out over a longer period of time, but it will cost you more money to pay it off, because you will be charged a higher interest rate.
  • **Obtain a special loan** if you are a high-credit buyer. If your credit history is almost spotless, you may qualify for special rates on new cars at certain dealerships. You will need to ask dealers individually about these rates.

Calculating The Costs

Once you know the interest rate you will have to pay, you can use one of the many car loan calculators available online to get a basic idea of the costs and ensure that you don't go over budget. From this information, you can see that a $10,000 car, using the average APR of 4 percent over a 36-month loan, will cost you about $630 per month. You will also see that the amount you are paying in interest goes down over time, while the amount of principal you are paying each month goes up, but the actual monthly payment stays the same.

More Ways to Save

  • Make your decision based on the cost of the loan, not just the price of the car. Even if the car seems like a bargain, if you are not getting the best deal possible on the loan itself, then you could pay more in total than you would if you had purchased a more expensive car through a different lender.
  • You don't have to get dealer financing to buy from a dealer. Go to your bank, inquire at credit unions and get a preapproved loan in writing that you can take to the dealer to negotiate with.

Tip

  • When you are trying to obtain the best interest rate, remember that the most important factor is your credit history, so that is the first thing to work on before applying for a loan.

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