Auto loan interest rates can make the difference between a car you can afford and a car that’s too expensive. While dealers often draw more attention to the car’s purchase price or the monthly payment amount, it’s important to look at the interest you’ll have to pay to understand how much the loan will cost. First, you want to find out what the annual percentage rate is.
Annual Percentage Rate
The annual percentage rate, or APR, is the percentage of the loan you pay in interest and fees over the course of a year. This is similar to an interest rate, but it’s more comprehensive because it includes the fees the lender charges. The APR tells you the annual cost of the loan. The government requires lenders to state the APR so consumers can easily compare the costs of different loans. Comparison shopping would be difficult if some lenders reported monthly auto loan interest rates instead of annual rates, or if they mentioned fees separately.
Fixed or Variable
The loan you’re looking at has either a fixed-rate APR or a variable-rate APR. With a fixed-rate APR, you’re charged the same rate until you pay off your loan. A variable-rate APR can change in the future if economic conditions change. As the Consumer Financial Protection Bureau explains, you take on more risk when you sign a variable-rate loan because your payments could end up increasing. Fixed-rate financing is safer for a loan that you’ll be paying back over several years, during which time interest rates could go up.
Simple or Precomputed
You should also check if the interest on the loan is simple or precomputed. Simple interest is calculated based on the amount of the loan you still need to pay. If you make some extra payments to pay off your loan earlier, the interest you owe on your remaining payments also goes down. In contrast, with precomputed interest you don’t get this reduction from paying ahead of schedule. Therefore, you don’t want a loan with precomputed interest if you’re going to try to pay off your loan before the payment schedule requires you to.
The Contract Rate
The interest rate the dealer first quotes you may not be the best rate you can get, and as with the purchase price of the car, some bargaining is expected. The interest rate you agree to pay is called the contract rate. The Consumer Financial Protection Bureau recommends that you ask the dealer for the buy rate, which is the interest rate the bank quotes the dealer for the loan, and then try to bargain down to a contract rate that’s not much higher than the buy rate. This negotiation is easier if you first get quotes from banks or other dealers. You can then show the dealer that you are considering other options, and the dealer will probably try to match the best rates offered by other lenders in order to win your business.
Finally, seeing the total interest you can expect to pay on an auto loan may help you decide whether its interest rate is affordable. Use a website like Bankrate’s loan interest calculator to find out how much interest you’ll owe on a fixed-rate loan based on the loan’s APR and monthly payment amount.
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