When you’re buying a new or used vehicle, you might prefer to finance your purchase with an auto loan rather than pay cash up front. Auto loans may offer favorable 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.
Here’s a brief glossary of basic car loan definitions that can help you select the right borrowing option.
Key Points
• Auto loans are contracts that outline repayment terms, including interest and fees, and understanding terminology can help you find the right product.
• APR, or annual percentage rate, reflects the total cost of borrowing, including interest and fees.
• Loan terms usually range from 2 to 8 years, affecting monthly payments and total interest.
• A down payment reduces the loan amount, lowering monthly payments and total interest.
• A cosigner assumes equal responsibility for the loan, helping secure financing for those with low credit.
Auto Loan
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 get an auto loan. Dealerships may also offer in-house financing, in which you repay an auto loan directly to the dealer.
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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 interest 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. This tends to be the most common type of car 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 change. 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, upgrades (like that premium sound system you’ve had your eye on), or purchase extended warranties or maintenance contracts.
Cosigner
Lenders typically use credit scores to determine whether you’re eligible for an auto loan or an auto loan refinance and what interest rate they’ll charge you. (The higher your score, the more likely you are to get the best, or lowest, interest rates.) 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.
An auto loan 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. A cosigner is usually a relative or significant other with a solid credit history. Keep in mind, though, that only the person whose name is on the title has legal rights to the vehicle itself.
Deficiency Balance
If you fail to repay your loan and your vehicle gets repossessed and sold by your financing company to recoup its losses, and 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, which means less money you’ll pay in interest 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.
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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 some 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 to 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, you mustn’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 to get a sense of the costs. That way, you’re comparing apples to apples vs. apples to oranges, as the saying goes.
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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.
Usually, car loans range from two years to eight years, though you may find exceptions. A loan term of five or six years is common.
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 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.
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Principal
When it comes to car loan definitions, it’s important to understand that auto loan principal is 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 loan’s 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.
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The Takeaway
Auto loans can vary, so it’s important to understand the terminology and 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.
If you’re seeking auto loan refinancing, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your car in minutes.
FAQ
What is the typical term for a car loan?
Car loan terms usually range from two to eight years, with five or six years being typical.
Are most car loans fixed-rate or variable?
Most car loans are fixed-rate, but variable-rate loans may also be available. While a fixed-rate loan could end up being more expensive if rates drop, it can be helpful to have a consistent monthly payment when budgeting.
What is a car loan’s APR?
A car loan’s APR is the annual percentage rate. This figure reflects the interest rate plus any other fees and loan costs. It more accurately reflects the cost of the loan than simply the interest rate.
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