Glossary of Auto Finance Terms

February 8, 2017.

There are a lot of things to consider when going through the process of getting a new auto loan or refinancing an existing one. It can get overwhelming trying to make a decision and understand the process, let alone understand all of the terms and acronyms that get thrown around. To help with that, we created this list of common auto finance terms, their definitions, and how they fit into the overall auto finance process.

 

  • Annual Percentage Rate (APR): calculated from the total loan amount, this is the interest rate you pay over the entire year, not just the monthly fee.
  • Book value: The answer to “what is my car worth?” Cars are valued based on criteria set by Kelley Blue Book and National Automobile Dealers Association (NADA). Make, model, year, trim, and additional features such as power windows, towing packages, satellite radio or navigation capabilities all play a role in determining the book value.
  • Cosigner: (sometimes called co-applicant) a friend or relative that joins your loan application to help the loan offer result in lower payments and interest rate, or to get your loan approved in general. The cosigner will undergo credit checks and is legally bound to your auto loan– meaning the cosigner will be responsible for making payments if you are unable to do so.
  • Debt-to-Income (DTI) ratio: the amount of money you owe (to all lines of credit) compared to the amount of money you make. Your DTI plays a big role in determining approval for an auto loan.
  • Down payment: a percentage of the purchase price you pay up front. Being able to put some money down will help reduce your monthly payments.
  • Equity: amount you “own” in your car loan; the amount you have paid on your loan. Dealerships and lenders take equity into consideration for trade-ins or refinancing. It is common to have negative equity, meaning you owe more on your vehicle than what it is currently worth.
  • Extended warranty: a vehicle service contract sold outside of the one provided by the manufacturer. Extended warranties have longer terms than manufacturer warranties and typically cover more in terms of service and parts.
  • Guaranteed Asset Protection (GAP) Insurance: a type of insurance coverage that covers the remaining balance on an auto loan after the insurance payout in the event a vehicle is totaled. GAP Insurance is beneficial because you will not have to pay off a loan for a car you no longer operate.
  • Interest: the cost you incur when you borrow money from a lender. Simple interest and compound interest are two types of interest in auto loans.
    • Simple interest: when interest from the principal from earlier periods is not calculated into the following periods. The majority of auto loans are simple interest.
    • Compound interest: when interest is calculated for every single period of the principal and also all of the interest that accrued in previous periods. With compound interest loans, you may end up paying more in interest than you would have on a simple interest loan.
  • Interest rate: the percentage that determines how much you’re paying to borrow money from a lender. There are two types of interest rates:
    • Fixed rate: an interest rate that does not change during the term of the loan. Almost all auto loans are fixed rate loans.
    • Variable rate: an interest rate that changes during the term of the loan. The change in rate is based on the current rate index. At times you may have a higher or lower interest rate than the original in your contract.
  • Principal balance: the amount of loan remaining unpaid, not including the interest rate or any other finance charges.
  • Proof of Income: document demonstrating you are employed and receiving the income needed to pay your loan. Examples are paystubs or tax returns.
  • Proof of Residence: document that proves you reside at the address on your loan application. Examples are rental agreements, utilities bill or a cable bill.
  • Title: a legal form that declares a person the legal owner of a vehicle. Titles are also known as pink slips.