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Glossary: Financing Terms

Most consumers will need to finance a new vehicle rather than paying upfront and in full. While buying a new vehicle in cash has benefits (like no interest payments), it is not realistic for all car buyers. If taking out an auto loan or financing a new vehicle, you should understand the financing terms before signing on the dotted line.

Use the definitions below to strengthen your understanding of the terms used in the vehicle financing and new loan process. This will help:

  • Empower you during negotiations with dealerships and financial institutions, which can result in more favorable loan terms and lower interest rates
  • Inform you of your financial commitment — you do not want surprises later about your monthly loan payment due date, interest rates, or how vehicle depreciation affects loan equity
  • Protect you from potential auto fraud or predatory lending practices, helping you avoid agreements you may regret later

Alphabetical Glossary of Financing Terms

Amortization: The process of paying off a car loan through scheduled payments over a specified period of time.

Amortization schedule: This outlines the specific details of each payment. It typically includes several aspects of each payment.

  • Full payment amount
  • Dollar amount allocated to interest
  • Dollar amount applied to the principal
  • Remaining outstanding balance after each payment

Assignee: The bank, finance company, or credit union that purchases the contract from the dealer.

Amount financed: The dollar amount of the credit you receive.

Annual percentage rate (APR): The cost of credit for one year expressed as a percentage. This is often referred to as the "interest rate."

Balance sheet: Provides a snapshot of an institution's financial position at a specific point. It shows the company's assets, liabilities, and equity to help stakeholders understand its financial health.

Balloon payment: Allows you to make smaller payments throughout the duration of a loan until the final balloon payment is due and payable. The balloon payment is a lump sum paid at the end of a loan that is usually significantly larger than the previous payments.

Consolidation: Combining multiple loans into a single loan to simplify the repayment process with a lower interest rate. With auto loans, consolidation usually involves taking out a new loan and using it to pay off two or more car loans.

Co-signer: Someone (usually a friend or family member of the borrower) who agrees to take on shared responsibility for the loan. A lender may need a co-signer if you have:

  • Limited credit history
  • Low income
  • A poor credit score

Credit insurance: Optional insurance that pays the scheduled unpaid balance if you die or scheduled monthly payments if you become disabled. As with most contract terms, the cost of optional credit insurance must be disclosed in writing, and if you want it, you must agree to it and sign for it.

Credit limit: A lender's maximum amount of credit will extend to a borrower. For example, if a lender approves you for a credit card with a $10,000 credit limit, you can't have an outstanding balance of more than that amount. Attempting to exceed your credit limit can result in declined transactions and extra fees.

Creditor: The organization lending you the money to finance a vehicle.

Credit score: The numerical representation of your creditworthiness used to determine how likely you are to repay money. Credit scores range from 300 to 850 and get calculated based on:

  • Length of credit history
  • Percentage of total credit used
  • Credit mix (like credit cards, student loans, mortgages, and auto loans)
  • History of on-time payments

The higher the score on your credit report, the more likely you are to get better loan terms and lower interest rates.

Depreciation: The decrease in the market value of a vehicle over time due to wear and tear, age, and market conditions. Depreciation affects the equity in your auto loan in that the loan balance may exceed your vehicle's market value during certain periods of ownership.

Disbursement: The payment of funds to the lender to cover the cost of the financed vehicle. When you get an auto loan, the lender disburses the approved loan amount directly to the dealership. This allows you to buy the vehicle and starts the repayment process to the lender.

Down payment: An initial amount paid to reduce the amount financed.

Extended service contract: Optional protection on specified components of the vehicle. This is available to buy to supplement the warranty coverage provided with the vehicle.

Finance charge: The total dollar amount you pay to use credit.

Financial institution: An organization that provides financial services, like checking accounts, loans, savings accounts, and investment services. Financial institutions that issue auto loans include banks, credit unions, automotive manufacturer financing companies, and specialized auto lenders.

Fixed-rate financing: A loan option where the finance rate remains the same over the life of the contract.

Guaranteed auto protection (GAP): Optional protection that pays the difference between the amount you owe on your vehicle and the amount you get from your insurance company. This is typically used if the vehicle gets stolen or destroyed before you have satisfied your credit obligation.

Liquidity: Your ability as a borrower to access readily available cash or assets you can quickly convert to cash. Examples of "liquid" assets include short-term investments or cash in bank accounts.

Market value: The current value of a vehicle in the open market. This represents how much a buyer would typically be willing to pay for the car in its present condition and mileage. The current economic market and supply and demand can also affect your vehicle's market value.

Maturity date: The date your auto loan is scheduled to be fully repaid. The maturity date is the end of the loan term, meaning the borrower should have made all required payments to pay off the loan.

Monthly payment amount: The dollar amount due each month to repay the credit agreement.

Negotiated price of the vehicle: The purchase price agreed upon by the buyer and the dealer.

Outstanding balance: The amount of money remaining unpaid on a loan or line of credit. It represents the total amount borrowed minus any applied payments. This differs from the principal balance in that it also includes accrued interest.

Principal balance: The amount of money on a loan or line of credit that has not yet been repaid. It represents the remaining amount of the original loan, excluding accrued interest and other fees.

Promissory note: Outlines the terms of a loan, including the total borrowed amount, rate of interest, and repayment schedule. It is a formal agreement that details your commitment to repay the loan.

Refinancing: Taking out a new loan to replace your existing auto loan. Essentially, this means to pay off the original car loan with a new loan from a different lender. This is often done to get a lower interest rate or better loan conditions.

Underwriting: The part of the loan process where the lender evaluates the risk of providing you a loan. The lender reviews various financial factors, including your:

  • Credit history and credit score
  • Income
  • Employment status and duration

Lenders use this information to determine your amount of interest, loan amount, and repayment terms.

Variable rate financing: The finance rate varies, and the amount you must pay changes over the life of the contract.

Concerns With an Auto Loan? Talk to an Attorney

Most automotive loans are fairly straightforward and don't need the help of an attorney. But, there are certain situations where it may be in your best interests to talk to a consumer protection attorney in your area:

  • You think you may have bought a lemon you financed through an auto loan
  • You may be the victim of manufacturer or dealership auto fraud
  • Your eligibility for financing or a new loan was not fairly considered

An experienced attorney near you can help represent your interests and negotiate with the dealership or manufacturer. Depending on the situation, they may be able to recoup your financial losses.

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