Understanding APR and how it affects your car loan

When shopping for a new car, most people are trying to get the best deal. While you could save some money by haggling with the seller about the price, or extras, you don't want to miss another opportunity to save. And that's on the rate of your car loan.

To get the best loan deal, you'll want to make sure you understand and pay attention to the loan's APR, or annual percentage rate. This represents the amount you pay each year to borrow the money. It's made up of the interest rate and any prepaid loan fees like an origination fee.

Lenders often try to lure buyers with low interest rates, but the APR is a more meaningful number and will give you the amount the loan will cost per year, assuming you stick to your payment schedule. The lower the APR, the less you'll pay for the loan. Since fees and rates vary by lender, you'll want to check with multiple lenders to see where you can get the best loan terms.

Not sure what factors affect the APR you'll be offered? Here are some of the factors lenders will use to determine whether they'll give you a loan, and how much you'll pay for it.

Your credit score

A major factor in determining your auto loan interest rate is your credit score. The better your credit score, the more attractive you'll appear as a borrower, so you're likely to be offered a lower APR.

It's a good idea to check your credit before you start car shopping, so you'll know where you stand. In general, your score is affected by your credit history. Paying your bills on time, keeping your outstanding balance well below your limits, maintaining long-term credit accounts and different types of credit accounts can positively affect your score. If you're worried about your score being low, USAA can offer tips to help you give it a boost.

Down payment

Another factor in your APR may be whether you're willing to make a down payment on the car. The more money you put down, the more likely lenders may be to give you a favorable interest rate. A down payment is an indication that you'll make timely loan repayments because you won't want to lose the car and the money you've already invested in it.

If you're willing to pay 10% or 20% of the car's purchase price up front, your lender may lower your APR. It's up to you to decide if you're willing to part with money today to lower your monthly payments, or if it's more important to you to keep that money in your bank account and pay potentially more for the loan.

Your income, expenses and employment history

While income is not a factor used to determine your credit score, lenders might factor it when judging your reliability as a borrower. They want to make sure you have enough money coming in to make your monthly loan payments.

Lenders may also look at other factors that help them get a better understanding of your financial standing. Things like account balances, debt payments and your employment history can indicate if you'll have a steady income.

The length of the loan

The longer the life of the loan, the lower your monthly payments might be. However, you'll have to weigh whether that's worth it to you. You'll make lower monthly payments but over a greater period. By the end of the loan, you may have spent more money on the car than you may expect to. Also, with a long loan term, your car's warranty might expire before you've finished paying off the loan. You could face paying for repair bills while also paying your monthly car payment.

Cars typically depreciate in value. A longer loan term puts you at risk of owing more on the car than what it's worth. New cars experience the majority of their depreciation within the first year they're on the road. Combined with the higher cost of a longer loan, you may be looking at a bigger expense than you might anticipate. It could be worthwhile to seek out a less expensive or older model for the chance to pay the loan off earlier and avoid any extra expenses.

New car versus used car

Some new cars can lose 10% to 20% of their value as soon they're driven off the lot, which might make you reconsider buying new vs. used. But keep in mind that the APR on a new car is typically lower than on a used car. That's because lenders consider used cars to be more of a risk because they're more susceptible to breaking down.

If the buyer defaults on the loan and the lender takes possession of the car, calculating the value of a relatively new car with one owner is easier than calculating the value of an older car that's been through multiple owners. Accordingly, a "gently used" car is likely to have a lower APR than a much older one.

Average APR Based on Credit Score for a New Car Versus a Used Car

Average interest rates for the first quarter of 2022. Rates can change frequently, consider these rates for educational purposes about credit scores and rate differences. Source: Experian^{See note®} and Business Insider^{See note1}

The bottom line: There's an array of factors affecting the APR you could get on your loan. Some are harder to control in the short term, such as your credit score, income and down payment.

Other factors, like the length of your loan, can come down to trade-offs. Can you afford a higher monthly payment so you can pay off the car sooner? Or do you need to have a lower monthly payment and are willing to have the expenses that can come with it?

The USAA Advice Center provides general advice, tools and resources to guide your journey. Content may mention products, features or services that USAA Federal Savings Bank does not offer. The information contained is provided for informational purposes only and is not intended to represent any endorsement, expressed or implied, by USAA or any affiliates. All information provided is subject to change without notice.