While shopping for car loans, credit cards, and other financial services, you have probably come across the term APR. APR stands for “Annual Percentage Rate.” It is the annual rate of finance charge you pay for your loan or credit line. For car loans, APR is the rate you pay that accounts for your interest charges plus all other fees you have to pay to get your loan.
To clarify how much you will pay in interest charges versus how much you will pay in interest charges plus fees, your car loan paperwork will likely come with two rates. Each gives you different information about your loan, yet mathematically they are the same in that they both give you the same payment (the one quoted on your loan paperwork) and both require you to pay the same amount for you car over the course of you loan.
The lower of the two rates is your interest rate or note rate. This rate describes how much in interest charges you will pay on the balance of your loan over a year period.
The higher rate will be your APR. The APR accounts for the total finance charge you pay on your loan in a given year. The finance charge is made up of both your interest charges and your prepaid finance charges, which are various charges rolled into your loan amount that can include different loan fees and the interest that accumulates to the day of your first loan payment. Even though your prepaid finance charges are included in your loan principal and so are indeed “prepaid,” you still pay for those fees with your car payments over the course of your loan, making the prepaid charges more like interest charges. Remember, just because your APR is higher than the interest rate quoted to you does not indicate that your lender has changed the loan terms it is offering you.
You can think of your two rates as follows.
Note rate or interest rate equation
(Note, the “loan amount” is the balance on your loan principal, which is the amount you borrow. The “interest charges” are those paid in a 12 month period.)
(Note, the “loan amount” is the balance of your amount financed or the amount you need to buy or refinance your car. The “interest charges + prepaid charges” are those paid in 12 month period.)
Please note, while these equations are helpful for understanding these two rates, they do not necessarily reflect how you would calculate the two rates. However, you can read much more about how APR works here, including how to use the above equations to correctly estimate your note rate or APR.