What's APR and How Is It Different from Interest Rate?

What's APR and How Is It Different from Interest Rate?

When you're on the hunt for a new vehicle, you want every piece of information available to make the best financial decision. Factors like MSRP, fuel economy, reliability, and loan options all determine your cost throughout ownership.

With most automotive purchases running in the range of tens of thousands of dollars, financing is an excellent option to spread out your obligation over time, taking the immediate hit off of your wallet. And on your auto loan, considerations like term length and interest rate will both affect your monthly payment and the total you owe.

But what about the annual percentage rate or APR? You may think interest rate and APR are the same things, as they're often used interchangeably in marketing language and everyday conversation when referring to loans or credit cards. 

But APR and the interest rate aren't precisely the same. What is APR, and how does it differ from the interest rate? Let's look at what makes each different and also how they're alike.

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What is APR?

APR stands for annual percentage rate. Starting with the sum of money borrowed, APR calculates the yearly interest owed on the amount, along with additional fees and costs.

A percentage rate indicates APR and considers elements like monthly payments, closing costs, and rebates. 

The Truth In Lending Act of 1968 requires lenders to notify borrowers of the APR on their borrowed sum. The APR provides borrowers with a clear idea of the total cost they'll owe over the term of the loan when compared to a basic interest figure that's less comprehensive. 

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How is the annual percentage rate different from the interest rate?

While APR considers multiple elements like principal interest, fees, and rebates, the interest rate is less complicated.

The interest rate on a loan is simply the percentage owed on the principal loan sum. With credit cards, interest is charged on the current balance. 

While APR and interest rate differ slightly, each can be taken into account as you apply for financing and look to secure the best deal. And APR and interest aren’t the only factors to consider when financing a vehicle purchase. 

The term length of the loan is also important and affects your monthly payment and how much interest you’ll pay over the months and years. In the end, finding the right balance between what works for you and your financial situation can put you behind the wheel of the vehicle you’ve been searching for. 

The different types of APR

Different categories of APR exist, depending on the type of transaction, along with other factors. Fixed APR and variable APR are the two main categories. 

In general, the APR for a credit card is higher than that of an auto or home loan. The types of purchases you make with your credit card can also affect the APR.

When you sign up for a new credit card, you'll likely have an introductory APR available. In many cases, this is zero percent for purchases within a specific time frame before eventually rising to a typical rate. 

Credit cards further complicate APR by charging different rates contingent upon the category of transaction. There could be one rate for purchases, another for cash advances, and another for balance transfers. 

With a fixed-rate APR, the rate throughout the loan never changes. Month after month, year after year, your costs remain steady and stable.

Conversely, a variable rate APR is subject to change during a loan. A variable-rate APR corresponds to an index interest rate such as the prime rate. Whenever the prime rate changes, so does the APR, which can change what you owe as time passes. 

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Factors affecting APR

Before applying for a loan or a credit card, borrowers must take several things into account.

As with any transaction involving borrowing money, your credit score is a significant factor. Taking a closer look at the elements making up your credit report, you can employ some good practices to improve it. 

Keeping up with your payments and being a reliable borrower over time tells lenders you're a safe candidate for credit. Avoiding excessive purchases and not exceeding your credit limit are indicators you're financially responsible and can be trusted. 

It's also a good idea to periodically check your credit report, so you're up to date before seeking out lenders. If there are penalties on your credit score you don't recognize, you can contact the reporting agency and try to fix the issue, possibly increasing your score in the process. Your credit report can also give you insights into how you can improve your rating by reducing your debt or other obligations.

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Summing up APR and interest rate

Financial terms can be confusing, and APR and interest rate are no exception. While they seem similar and sometimes alike, there are significant differences to keep in mind. 

Whether you're taking out a car loan or applying for a new credit card, knowing the difference between APR and interest rate can save you money over the long haul.

But APR and interest rate aren’t the only thing to pay attention to, as factors like the term length of an auto loan also come into play and affect how much you owe over the months and years. 

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Author
Shift Editorial Team