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How is a car loan APR calculated?

how is apr calculated on a loan

APR Eligibility

Auto lenders and car companies often use terminology like "for well-qualified buyers" when referring to interest rates in advertising. Qualifying for auto financing is directly tied to the creditworthiness of a buyer. Auto lenders use credit reports and credit scores to determine both creditworthiness and the level of qualification for an interest rate. Credit scores are determined by a person's history of borrowing, repayment and how much debt they hold. Credit scores range from 300-850, with the higher number being the best possible score. The higher the credit score, the lower the interest rate. Well-qualified buyers are often classified as individuals with a credit score between 720-850.

How the Rate Is Calculated

The rate assigned to the loan is based on above eligibility. The difference between someone with a credit score of 800 and someone with a 700 could be upwards of 1/4 of 1 per cent. While it does not seem like a large figure, 0.25 per cent could represent hundreds of dollars in the end. Interest rates typically step up as the credit score decreases. Lenders, like banks and auto financing companies, find the best possible interest rate by shopping a buyer's record around once a score is determined. For lenders, it is about making money and how the company can make the

most margin (the difference between the loan and actual cost of servicing the loan). While the creditworthiness of the buyer factors in, so does the size of the loan. A £13,000 car and a £26,000 car would have different interest rates attached to them, as the higher loan generates a greater potential of income through interest as well as presenting a greater risk of default, or failure to repay. The term of the loan also affects the calculation of the interest rate. The longer the loan, the more work the lender must perform and the greater risk of default. For instance: An automaker sells £19,500 car and its lending arm offers a special incentive APR to stimulate sales. Qualified buyers are offered the option of purchasing the car and paying it back over a 36-, 48- or 60-month term. The 36-month term will have the best rate, as it will take less time for the bank to recoup its loan. For this example, it is 2.9 per cent. A 48-month term creates a riskier scenario for the bank and need to make more money. As a result, it will increase its rate 1 per cent to 2 per cent. The same scenario applies to the 60-month loan, which will step up 1 per cent to 2 per cent more.

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