What is an APR?
What is an APR?
Now that you’ve made up your mind about the car you wish to purchase, there’s one aspect you need to pay attention to when applying for an auto loan. If you’ve ever received a vehicle loan contract, you will have noticed two interest rates if you had scanned the document thoroughly. It may sound weird to have two interest rates but it would not indicate that the lender intends on changing the plan. It’s nothing but a practice usually seen today in most documents.
The two different rates on the contract are present to give you a clear understanding of the loan. Of the two rates, the lower one indicates the actual rate and the other one indicates the Annual Percentage Rate or APR. Let’s understand what these two mean and how it works:
APR vs. Interest Rate
Having accepted a loan, you will bring a compensation to your lender for the services in exchange for the funds borrowed. This compensation could be seen through an interest rate considering that is what lenders prefer over other types. The interest would, however, make up for a quarter of the funds charged. One would also need to invest in prepaid finance charges as a form of compensation. As a matter of fact, these prepaid charges are what hold a clear distinction between an interest rate and APR.
The prepaid finance charge consists of the charges and fees that one would need to pay to their lender or a particular institution before investing in a vehicle. Most of the time, you wouldn’t even notice paying this amount considering that it doesn’t go into cash or out of your pocket. As a matter of fact, these charges are buried into the principal amount or borrowed money. This would, therefore, mean that you would borrow this money and pay it back over a specific period of time.
The interest rate is measured as the cost of borrowing money, even if a part of this cost would be proceeded toward the compensation amount and not toward the vehicle. The interest rate is, therefore, treated as the prepaid finance charge and may seem like a part of the vehicle price. Under this interest rate, it is important that you understand that the prepaid finance charge would not be a part of the finance cost.
The APR, on the other hand, would consider the prepaid finance charge as part of the total finance charge. The APR would be based on the fact that you will be able to pay off the entire loan. This would also include the monthly payment along with its interest charge as well as the amount borrowed for the prepaid charge.
Here, you will want to keep in mind that the APR will come across higher than the interest rate considering that it reflects the compensation amount to be paid to the lender. It comes across as a beneficial option given the fact that they reveal the total financing cost of the car investment and is one of the reasons why many use it as measuring stick today.
Make sure to understand what is it that you’re getting into. Take some time to research or even talk to investors or people with sufficient experience.