Okay so just a simple problem. I am trying to understand how APR works but like i just dont get it. Context im trying to figure it out cause im 17 and some point in the next year i wanna get a car, but obviously gotta understand APR first. so please explain it to me like you are talking to someone you know is a complete idiot, cause i dont get it.
I need help cause i am kinda stupid.
byu/Josh24forever inpersonalfinance
Posted by Josh24forever
9 Comments
This shows the math of how car loans work.
https://www.peopledrivencu.org/wp-content/uploads/2020/06/PDCU-daily-simple-interest.pdf
Do your best not to take out a loan on a car when you are 18. But certainly learn about interest and amortization tables.
You’re not stupid. 17 is a great time to be learning about APR. Props to you and continue educating yourself about money. It is the greatest tool there is!
When you take out a loan, there’s an interest rate on the loan that’s going to be the main driver of how much this will cost you. But because there might also be additional fees (either to originate the loan, or whatever), a standardized method is used to compute an APR, which attempts to account for these fees so you can compare loans more readily. Because loans can still use different methods of compounding it isn’t perfect, but it’s a good start.
Did you try searching for explainers on Google?
APR is just how much more you owe on the principal loan every year.
I lend you $100 at a 10% APR, you’d owe me $110 this time next year. If you pay me back tomorrow, you’d have to only pay me a tiny bit over $100.
That’s a very simplistic and somewhat inaccurate explanation, because the interest doesn’t only grow once a year, and for a real loan, you’d be paying it back during that year, but hopefully you get the gist of it.
Basically, lower the APR, less interest you pay. If you can pay it off before your loan term ends, it’s extra money in your pocket that you aren’t paying towards interest.
A is for annual. The super basic idea is that you owe the apr for the money you owe. 10% apr and $5000 borrowed you’d owe $5500 for a 12 month loan.
While it’s more complicated than that, you can look at car loan amortization schedule to see it in more detail.
APR is the cost to borrow money. Basically, you will pay a monthly payment + a percentage of the total loan amount each month. Higher the APR, higher the cost to borrow the money. When you have a low credit score or no credit, the APR will be higher, as the bank sees this person as a risk. High credit score? Bank sees less risk and you’ll get a lower number.
Dealerships will want you to take a loan through them. They will make more money this way. You should go to a credit union. You will need a co-signer, or a parent/relative who will be forced to pay the bill if you cannot.
Let’s say I take out a $10,000 loan. The APR is 20%.
So take $10,000 * 1.2 = $12,000
The $2,000 is interest and can carry over into the next year (it gets multiplied again).
Now next year, take $12,000 * 1.2 = $14,400
Basically, it’s like plugging into a calculator “loan amount * interest = new total”. Every year you hit “equals” sign on that calculator and the number goes up.
That’s a **gross** oversimplication since there should be minimum monthly payments among other things, and you generally also have the option to pay down more. But it hammers home the point of “compounding interest” (taking a number, multiplying it by a percentage, then hitting “equals” to calculate a new total every year).
If you only make the minimum payments, the loan costs you more. If you try to pay off the loan as quickly as possible, the loan costs you less.
It’s a really long way to say that a “loan” of $10,000 can cost you $20,000. And you might be paying more for a car than what you see on the price tag.