Understanding How APR Works For Your Customers
When reviewing financing details, it's important to understand how the Annual Percentage Rate (APR) is applied. A common mistake is assuming that APR works like simple interest, but it’s actually calculated differently over the loan term.
How APR is Applied
Instead of applying a flat percentage to the total loan amount, APR is spread over the entire loan term and applied to the declining balance as payments are made, like the below example demonstrates.
- Amount Financed: $1,791.50
- Loan Term: 18 months
- APR: 4.99%
- Total Finance Charge: $75.28
- Total Amount Paid: $1,866.78
If you were to multiply $1,791.50 × 4.99%, you’d get $89.39—but this is not how APR is calculated in financing plans. Instead, interest is applied gradually over time, leading to the final finance charge of $75.28.
Why Do Payment Amounts Look Slightly Different?
In some cases, you might notice a small difference in quoted monthly payments (e.g., $103.51 vs. $103.71). This is usually due to rounding differences across systems. The legally binding amount will always be the one shown in your financing contract.
How to Confirm the Numbers Are Correct
You can verify the total cost using a simple check:
- Multiply the monthly payment by the number of months:
- $103.71 × 18 months = $1,866.78 (total amount paid)
- Subtract the original loan amount from the total paid:
- $1,866.78 - $1,791.50 = $75.28 (finance charge)
Since this matches the final finance charge, you can be confident the calculations are correct.
How Paying Off Early Reduces Interest
Because interest accrues daily, paying off your balance early reduces the total amount of interest you owe. Since the loan balance decreases faster, there are fewer days for interest to accumulate, lowering the total cost of borrowing.
For example, if you pay off the remaining balance a few months early, the total interest paid will be less than $75.28 because fewer days of interest have accrued.