Car Loan Terms Explained

Rebecca Lake

Updated February 16, 2021

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When you’re buying a new or used vehicle, you might prefer to finance your purchase with an auto loan, rather than pay cash upfront. Auto loans may offer low interest rates for buyers with good credit history and stable income. Before signing off on any vehicle financing, however, it's important to be sure you understand some basic auto loan terminology. That can get complicated. While some car finance terms are relatively straightforward, others are more complex. If you aren't an auto loans terms expert, you may find decoding the lingo a little daunting.Reviewing a brief glossary of basic auto finance terms before you begin shopping for a vehicle or a loan can help you feel more secure you’re ending up with the right borrowing option. Here are some of the most important car loan terms and definitions to know.

Auto Loan Definition

What is an auto loan? In a nutshell, a vehicle loan is essentially a contract between the car buyer and the financing company or lender. This contract spells out the conditions for completing the purchase of the vehicle and lays out exactly how the loan will be repaid over time. Banks, credit unions, online lenders, and financing companies are all places you can seek out auto loan financing as a car buyer. Dealerships may also offer in-house financing, in which you repay an auto loan directly to the dealer.

Annual Percentage Rate

Annual percentage rate (APR) is one of the most important car finance terms to know because it relates to how much you'll pay for a vehicle loan. APR is a reflection of the annualized cost of borrowing money, based on the interest rate and fees charged by the lender. In auto loan terminology, APR gives you a simple way to compare the cost of different vehicle loans. Say you have two lenders you're considering for vehicle financing. One offers a loan with a 3.99% APR while the other is advertising a 2.99% APR. Of the two, the second loan will cost you less money in interest over time. When you’re comparing APRs for vehicle loans, pay attention to whether rates are fixed or variable. A fixed APR stays the same for the life of the loan, which means you can easily calculate the total amount of interest you'll pay. Your monthly payments will also stay the same for the life of the loan. With variable rate auto loan financing, the APR is tied to a benchmark rate, such as the Prime Rate. If the benchmark rate increases or decreases, the loan's APR can also increase or decrease. This makes it more difficult to predict total interest costs, and monthly payments may not stay the same throughout the life of the loan.

Base Price

When you’re applying for auto loan financing, you may see the term base price mentioned. Base price reflects the purchase price of the vehicle as is, without add-ons. The actual purchase price may be higher if you add on optional equipment or upgrades or purchase extended warranties or maintenance contracts.

Cosigner

Lenders can use credit scores to determine whether you're eligible for an auto loan and what interest rate they’ll charge you. If you don't meet a lender's minimum credit score and income requirements, you may need a cosigner if you want to finalize the loan. A cosigner is someone who agrees to assume equal responsibility with you for an auto loan. If you default on the loan and fail to pay it back, the cosigner is liable for repaying what's owed.

Deficiency Balance

Deficiency balance is a car loan term that ideally you’ll never encounter in real life because you'll be able to pay off what you borrow as scheduled. When you owe a deficiency balance, it means that you failed to repay your loan and your vehicle was repossessed and sold by your financing company to recoup its losses. If you owe more on the car than the company is able to sell it for, the financing company can still hold you responsible for paying the difference. That gap is called the deficiency balance. You may also be responsible for paying any repossession fees.

Down Payment

A down payment is a payment you make upfront against the purchase price of a vehicle you're buying. This is similar to a down payment you might make on a home--the goal in both cases is to reduce the amount you need to finance.Depending on your credit and where you're buying your vehicle, you may be able to get auto loan financing with no money down. But there are some advantages to making a larger down payment. For one thing, you'll have a smaller loan as a result. That means less money you'll pay interest on over the life of the loan. A smaller loan can also lower your monthly payments, which can make financing a vehicle more affordable for your budget.

Extended Warranty

If you're buying a new or used vehicle from a dealer, you might be asked if you want to purchase extended warranty coverage. Extended warranties may cover basic maintenance or repairs to the vehicle for a period of time beyond the original manufacturer's warranty. Whether it makes sense to pay extra for an extended warranty can depend on the age of the vehicle, how long you plan to own it, and how much cash you have in reserves to cover repairs and maintenance. The cost of an extended warranty can be added into your auto loan's terms, meaning it would affect your monthly payment.

Interest Rate

The interest rate on a vehicle loan is simply the rate that's charged annually, without factoring in any fees. Interest rate was already mentioned as a part of your APR, but it's helpful to know what it means by itself, too. A lower interest rate can translate to a lower APR, but when you’re comparing car finance terms, it's important that you don't get the two of them confused. If you have two loans you're considering, you may want to look at each of their interest rates side by side as well as their APRs side by side to get a sense of the costs.

Loan Term

A car loan term simply means how long you'll make payments on the loan. Auto finance terms may largely depend on how much you're borrowing. A larger loan amount might require a longer loan term so that your monthly payments are affordable for your budget. A smaller loan may require less time to pay off.Monthly cost is important to consider when choosing a car loan term, but also think about what the timeframe means in terms of how much interest you'll pay. Generally, the longer the loan term, the more the interest charges will add up to over time. Paying off a shorter loan term could make the payments higher, but it can reduce the amount of interest you’ll pay altogether.

Loan to Value Ratio

Loan to value ratio (LTV) represents the total dollar value of your vehicle loan divided by the car's actual cash value. Actual cash value is what the car is worth according to independent valuation providers, such as Kelley Blue Book. Making a larger down payment can reduce your LTV ratio.

Principal

Principal is basic auto loan terminology for the amount you owe minus any interest, fees, or finance charges. When you make payments on a vehicle loan, part of what you pay is applied to the fees and interest, while the rest is applied to the principal.Your lender or financing company should provide you with an amortization schedule that breaks down how your payments are applied. Typically, a higher percentage of your payments will go toward interest and fees during the early part of your loan term. Once most of the interest is repaid, more of your payments will go toward the principal.

Total Cost

Total cost is a simple car loan term that means the total amount you'll pay for financing. This amount includes the principal, interest, fees, and any money you apply toward a down payment.

The Takeaway

Auto loans can vary a lot so it's important to do your research before selecting one. When you’re comparing vehicle financing options, it’s a good idea to consider what different lenders offer in terms of interest rates, fees, repayment terms, and loan amounts. Bear in mind, too, that there’s more that you can do beyond learning the terminology and shopping around to improve your chances of getting the financing you want. Working on improving your credit rating (by making regular payments on your credit cards and other loans) can give you access to better car loan rates. And paying a down payment or getting a cosigner with excellent credit may also help you qualify for better loans and reduce your car financing costs overall. Also, should you decide to make changes in the future, you can explore refinancing a car loan.

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About the Author

Rebecca Lake

Rebecca Lake is a freelance writer specializing in personal finance, investing and small business. Her work has appeared online at U.S. News and World Report, Forbes Advisor, CreditCards.com and Investopedia. Rebecca writes about a variety of topics for SoFi, including budgeting, saving money and student loans.

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