Should you take this loan? How to read an APR

Loans

The monthly payment is the number in the advertisement. The total cost is the number that decides whether the loan was a good idea. Here is how to get from one to the other.

The four numbers on every offer

• The APR — the yearly cost of the loan including finance charges, not just the interest rate.
• The term — how many payments you will make.
• The monthly payment.
• The total of payments — everything that leaves your account by the end.

Truth in Lending disclosures require the lender to give you the amount financed, the finance charge, the APR and the total of payments in one box. That box, not the marketing page, is the offer.

An interest rate is not an APR

The interest rate is charged on the balance. The APR folds in that rate plus finance charges such as an origination fee, and expresses the whole cost annually. Two loans quoting the same rate can carry different APRs when one of them charges a fee. Compare APR with APR, over the same term, or you are not comparing anything.

What a longer term actually does

A longer term lowers the payment and raises the total, because interest has more months in which to accrue. The arithmetic is short: payment times months gives the total repaid, and the total repaid minus the amount financed is what the loan cost you. Run it at every term the lender offers. The gap between those totals is the price of the smaller payment, and it is usually larger than people guess.

Fees that never appear in the advertised rate

• Origination and administrative fees, and whether they come out of the proceeds or get added to the balance.
• Prepayment penalties, and how they are calculated.
• Late fees and returned payment fees.
• Add-ons such as credit insurance or an extended warranty financed into the loan, which you then pay interest on.

Advertised rates are not offers

An advertised APR generally goes to the best-qualified applicants. Many lenders will pre-qualify you with a soft inquiry and show your likely rate without a hard pull. Collecting two or three of those before you formally apply costs nothing.

Before you sign

1. Find the Truth in Lending box and read the total of payments.
2. Confirm whether the rate is fixed for the entire term.
3. Ask in writing whether there is a prepayment penalty.
4. Check that nothing has been added since the quote — insurance, warranties, fees.

This is general information about how these products work, not advice about your own situation. For that, talk to a qualified professional.