Car Loan Glossary: Ultimate Guide to Auto Loan and Financing

Buying or refinancing a car is both exciting and intimidating whether or not it’s your first time.

To make life easier, this car loan glossary can help you understand the ins and outs of the auto finance industry.

Here are some examples of common auto loan terms you need to know to secure the car deal you deserve.

Add-ons

These are optional and beneficial features you can add to your car loan. For example, you can choose to add VIN etching, tire and wheel protection, and more.

Adverse Action

An adverse action is when a creditor rejects your loan application because of a poor credit score.

Adverse Action Notice

Lenders provide an adverse action notice to a borrower if they deny the loan application.

Amortization

This refers to the gradual payment of a car loan in regular installments. A part of each payment covers the principal amount and the interest.

Amortization Table

Amortization schedules show the breakdown of your loan principal and interest payments over the life of the loan. This way, you’re aware of how much you should pay and the overall cost of your loan.

Amount Financed

Amount financed is the loan amount that a lender lets you borrow. This can include the car’s cash price, optional features, and other loan-related fees.

Annual Percentage Rate (APR)

APR is the percentage rate that shows the true yearly cost of your car loan. For example, it considers the interest and other charges that come with the loan. Because of this, the higher the APR is, the more the loan costs.

Auto Test Drive

This is when a buyer tests the vehicle for overall quality and performance.

Automatic Payment

To make loan payments easier, many banks and lenders offer automatic payments. The autopay feature automatically deducts payments from your bank account on every due date. This way, you won’t have to worry about late or missed payments.

Bad Credit

Generally, a score below 580 is considered bad credit or poor credit.

Balloon Payment

Rather than having equal installments, a balloon payment involves making lower monthly payments. After that, you pay a lump sum toward the end of the term.

Base Price

When applying for a car loan, the base price is the cost of a vehicle before you add any extra features.

Bill of Sale

A document that confirms the seller or dealership has sold the vehicle to you. It also contains details about the car and the transaction.

Black Book Value

Dealers use the Black Book to look for information on the wholesale price and market value of new and used cars, trucks, and vans.

Blue Book Value

The Blue Book Value refers to a vehicle’s value based on Kelley Blue Book, Inc. This book provides details about expected prices that drivers can pay or receive for a vehicle.

Buydown

Buydown is an option to get cheaper interest rates for a certain period, typically at the beginning of your car loan. Even if you pay an upfront fee, this technique can help you save on the overall interest.

Car Purchase Agreement

It serves as the sales contract between you and the dealer that outlines the legal terms and details about the vehicle purchased.

Cash Back Refi

Cash-back auto loan refinancing allows you to earn cash back when you refinance your vehicle.

Cash Price

When purchasing a car, the cash price is the amount that the buyer agrees to pay the dealer.

Certificate of Title

Also known as the pink slip, the certificate of title is a document that proves your legal ownership of the vehicle.

Co-buyer

A co-buyer is a person who agrees to be responsible for repaying the loan with you. Let’s say you apply for an auto loan with your partner. Since your partner is a co-buyer, you have joint ownership of the car.

Collateral

Collaterals are any assets that you offer to secure the loan. In an auto loan, it’s usually the vehicle. The bank or lender may seize the collateral in case you fail to pay off the loan.

Collision Insurance

This type of insurance protects you from loss or damage to the car caused by a collision with another vehicle or an object.

Comprehensive Insurance

Comprehensive insurance is a type of coverage that pays for non-collision loss or damages to the vehicle. It covers fire, flood, theft, vandalism, and extreme weather.

Co-Owner

The second owner of the vehicle.

Cosigner

The cosigner is responsible for repaying the loan if the primary borrower can’t. But unlike a co-borrower, a cosigner doesn’t own any portion of the loan.

Credit Agency

Credit reporting agencies or credit bureaus collect, calculate, and report credit scores to creditors and lenders. Each credit bureau uses a different formula to calculate your credit score. In the U.S., the three major credit agencies are Equifax, Experian, and TransUnion.

Credit History

Your credit history shows how you manage and pay off your debts, such as credit cards and other loans. It’s indicated on your credit report and is a primary factor that affects your credit score.

Credit Report

This records your credit history, including past and current debts, payment history, and more. It’s important to check your credit report, so you can find and correct any errors.

Credit Score

The credit score rates your creditworthiness with a three-digit number and ranges from 300 to 850. Since there are three major credit bureaus in the U.S., you can have multiple credit scores.

Creditworthiness

When you apply for a car loan, lenders measure your creditworthiness to evaluate your ability to pay it back. Your credit score and other financial credentials influence your creditworthiness.

If you’re a responsible borrower, lenders are likely to approve your loan and offer favorable terms. However, they can deny your application or offer higher rates and fees if you are considered a risky borrower.

Debt-To-Income Ratio (DTI)

Your DTI is expressed in percentage and shows how much of your gross monthly income goes to your debt payments. Lenders use your DTI ratio to assess your capability to manage your monthly bills.

Default

When you miss payments for a few months, you can be in default. The timeframe depends on your lender and the terms of the agreement. When this happens, the lender may seize the collateral.

Delinquency

Your loan is considered delinquent when your payments are a few days behind the due date.

Department of Motor Vehicles (DMV)

This refers to a state agency responsible for the process of registering and licensing vehicles in each state.

Depreciation

Depreciation is the decrease in a vehicle’s value over time.

Destination Charge

This is a fee added to the dealer invoice for shipping the vehicle from the manufacturer to the dealer.

Direct Financing

It’s a type of auto loan directly from banks, lenders, and credit unions. This means you work with financial institutions to find and compare loans.

Down Payment

When buying a vehicle, the down payment is the portion of the purchase price that you pay in cash or any trade-ins.

Due Date

This refers to the monthly date that your payment is due.

Duplicate Title

When the original certificate of title is lost or damaged, you can request to reissue a title.

Electronic Funds Transfer (EFT)

This process enables transferring funds electronically from one account to another.

Equal Credit Opportunity Act (ECOA)

The ECOA is a federal law that forbids lenders and creditors from any form of discrimination. It includes race, color, national origin, religion, age, sex, marital status, or receipt of public assistance programs.

Equity

In auto loans, equity is the difference between the current value of your vehicle and your loan balance. Positive equity means your car is worth more than your loan balance. Meanwhile, negative equity means your car is worth less than what you currently owe.

Extended Warranty

This warranty covers the cost of repairs or maintenance after the manufacturer’s warranty expires.

Fair Market Value

When purchasing an automobile, it’s the realistic amount that a buyer is willing to pay for the vehicle in an open market.

Finance Charge

The overall cost of borrowing money — the interest as well as all upfront fees associated with your auto loan.

Fixed Interest Rates

Fixed interest rates remain the same during the loan term. Let’s say your car loan has a fixed rate of 6.82%. Regardless of market conditions, the auto loan rate stays the same until the end of your term.

Grace Period

When your payments are late, the grace period is the time during which you don’t have to pay penalties and don’t accrue interest. Usually, the grace period for auto loans is 10 to 15 days.

Gross Income

When you apply for a loan, one of the things lenders look at is your income. Your gross income refers to the money you earn before taxes and other deductions.

Guaranteed Automobile Protection (GAP)

Gap insurance covers the difference between your vehicle’s value and your auto loan balance if your car is damaged or stolen.

Guarantor

A guarantor is a friend or family member who agrees to pay your car loan in case you can’t. Essentially, having a guarantor is beneficial if you have a low income or poor credit history.

Hard Credit Check

To determine how much risk you pose, lenders check your credit as part of the loan application process. A hard credit check, hard inquiry, or hard pull is when a lender requests your credit report. In turn, it can temporarily decrease your score a bit.

Indirect Financing

Also known as dealership financing, this option refers to when you use a dealer to arrange your finance for the vehicle.

Insurance Premium

It’s the payment to any insurance company to cover the insurance cost.

Interest Rate

The interest rate represents the cost that banks or lenders charge you for borrowing money. It’s expressed as a percentage, and it doesn’t include the principal amount and other fees associated with your loan.

Invoice Price

This is the amount a dealership pays when buying a car from a manufacturer.

Late Fee

Depending on your lender, you may need to pay a late fee if you make any payments past the due date.

Late Payment

A late payment refers to a payment made after the due date. For example, if your due date is every 13th of the month, any car loan payment beyond the 13th is considered late. Most importantly, late payments can harm your credit score, so make sure you pay your bills on time.

Lease

The agreement between you and a company or dealership when you borrow a vehicle for a certain mileage and period.

Lemon Law

These are state laws that protect buyers from persistent quality and performance issues linked to the purchased vehicle.

Lessee

The individual who temporarily uses the leased vehicle.

Lessor

This pertains to the company that supplies the vehicle during a lease agreement.

Lien

When you apply for a secured loan, the lender puts a lien on your collateral. A lien is a legal claim that shows your lender has the right to repossess the vehicle if you can’t pay back your debt.

List Price

Also called the Manufacturer’s Suggested Retail Price (MSRP) or sticker price, this is the manufacturer’s recommended selling price of the vehicle.

Loan-to-Value Ratio (LTV)

LTV is the ratio of your loan amount to the vehicle’s value, and it is calculated by dividing the loan by the MSRP. For example, if the car’s value is $28,000, and you borrow $22,400, your LTV is 80%. When assessing your loan, the higher the LTV, the riskier the loan is.

Markup

The markup is the difference between the invoice price and the sales price.

Motor Vehicle Report (MVR)

Your MVR is the official record of your driving history, including any traffic tickets, accident reports, and more.

Payment-to-Income Ratio (PTI)

The PTI shows the percentage of your gross monthly income that goes to your auto loan payment. Usually, lenders prefer a PTI of no more than 15%-20%. To calculate your PTI, multiply your pre-tax monthly income by 0.15 or 0.20.

Prepayment Fees

Sometimes, lenders charge prepayment fees or exit fees when you pay off your auto loan before the final payment due date.

Prequalification

Getting prequalified for a loan is a fast way to let lenders check your eligibility and estimate how much you can borrow. Prequalification doesn’t formally guarantee your application, and it doesn’t affect your credit score.

Principal

The principal refers to the original amount of your loan. This means that it doesn’t yet include the interest and other fees. For instance, if you take out a $5,000 loan, your principal amount is $5,000.

Refinancing

Refinancing an auto loan replaces your existing loan with a new one. Essentially, you want to refinance to a more competitive rate or favorable terms to save on interest. It can be a great idea to refinance if you want to change your loan term or if your financial situation changes.

Repossess

If you default on your loan and cannot meet your financial obligations anymore, your lender can legally reclaim the vehicle.

Secured Loan

Traditionally, car loans are secured, which means you are required to set an asset as collateral. In this case, the lender can seize the vehicle in case you fail to pay your loan. Since you pledge collateral, secured loans tend to offer better rates and terms.

Service Charge

This fee may include the costs that the dealership incurs from delivering the vehicle and the finance company from funding the loan.

Simple Interest Auto Loan

In a simple interest car loan, your interest payment is based on your current unpaid principal balance. Your payments are split into interest and principal. Because of this, your principal balance decreases with the interest charges as you make your monthly payment.

Soft Credit Check

A soft inquiry or soft pull happens when lenders check your credit report for prequalification. Unlike a hard inquiry, a soft credit check doesn’t impact your credit score.

Term

Your term is the number of months or years you have to pay back your debt. If you take out a 36-month car loan, your repayment period would be three years.

Title Loan

A car title loan allows you to borrow money in exchange for your car title as collateral.

Total Sales Price

This relates to the total cost of your credit purchase, such as any down payment, loan amount, and finance charge.

Trade-In Allowance

When trading an old car, the trade-in allowance is the amount that the dealer subtracts from the cost of your new vehicle. In turn, this can reduce the cash price you need to pay when making a new purchase.

Trade-in Value

This is the value that a dealer offers when you trade in your used vehicle.

Truth-in-Lending Act

A federal law that requires lenders to disclose loan terms and costs to borrowers before signing for a loan. This obligates them to provide the loan details, such as the annual percentage rate, finance charge, and amount of loan.

Underwriting

It involves the process of validating data, assessing loan applications, and approving loan terms.

Unsecured Loan

An unsecured auto loan is a personal loan used to buy a car. Since it’s unsecured, lenders can’t seize the automobile if you default on your payments. However, unsecured car loans tend to have higher interest rates and stricter criteria.

Upside-down

Being upside-down, underwater, or in negative equity means you owe more on your car loan than your vehicle’s current value.

Usury Law

Usury laws vary per state, and they set the maximum interest rate that lenders can charge on an auto loan.

Variable Interest Rates

A variable interest rate rises and falls based on a lender’s prime rate and market conditions. In other words, your monthly payments are higher when the prime rate increases.

Vehicle Identification Number (VIN)

The VIN refers to the 17-digit alphanumeric assigned to a vehicle and is mostly located on the dashboard.

The Takeaway

Shopping for your dream car is challenging enough. With a solid understanding of this auto loan glossary, you can compare and narrow your options. This way, you make smart financial decisions that can help you save money and enjoy your ride with comfort and confidence.