The interest rate is an annual cost to the borrower for borrowing money in the form of a mortgage or automobile loan. It’s expressed as a percentage. Like the interest rate, the APR is expressed as a percentage. However, the APR includes other fees and charges, including broker fees, mortgage insurance, discount points, closing costs and loan origination fees. This is why the APR is often higher than the interest rate.
Knowing the difference between these two rates could end up saving you thousands of dollars on a mortgage.
Why is it Important to Consider Both?
Both APR and interest rate have various limitations that can make it difficult for you to determine and understand the actual cost of a mortgage. However, when taken together, you can utilize both rates to figure out the total cost of the loan. According to financial experts, the trick is to fully understand the complex interplay between these two numbers.
If you’re mostly concerned if you can afford the minimum monthly payments, then pay more attention to the interest rate. On the other hand, if your focus is on the aggregate costs of your loan or mortgage, it’s better to use the APR as a tool to compare the total costs of two or more loans.
Time Horizon is Important
If you’re planning to keep your car until you absolutely need to buy a new one, it makes a lot of sense to choose a loan with the lowest annual percentage rate possible. That’s because you end up paying the least amount possible for the car over the life of the loan.
On the other hand, if you don’t plan on keeping the car for very long, the APR shouldn’t matter as much, because you’ll likely not pay off the entire loan before trading in your next car for something else. At that point, it doesn’t matter as much; you should simply look at getting the best deal possible month-to-month.
The APR spreads the costs and fees of your loan over the term of your entire loan. As a result, its value is only optimized if you plan to keep your car during the entirety of your loan.
Know the Loan’s Break-Even Point
If the duration of your auto loan is relatively short, such as three to five years, it’s important to calculate the break-even point of your auto loan. There are various point calculators available online that can help you figure out the break-even point.
For instance, let’s say that you chose to buy down the APR on a loan by 0.35% in exchange for paying an extra 1.5 points, but moved in six years. You will lose considerable money. This is because the break-even on these points was actually seven years.
The unfortunate reality is that these calculations are quite tricky and are usually confusing for a majority of potential car buyers. This is why choosing the right lender is very important.
According to the US Federal Truth in Lending Act, all consumer loan agreements are required to prominently disclose a loan’s APR. As all lending institutions are required to follow the same set of rules for ensuring the accuracy and transparency of an APR, a borrower could use the loan’s APR as a useful basis to compare specific costs of loans.
Always keep in mind that your monthly repayment isn’t based on your APR; rather it is based on your interest rate mentioned in the promissory note. Therefore, carefully evaluate whenever you consider the loan rates offered by various lenders. Compare a loan’s annual percentage rate against another loan’s annual percentage rate in order to make a fair and meaningful comparison of the total costs.
Let AutoGravity Worry About the Calculations