The idea of a car loan is simple, but sometimes the application process can be a complicated and stressful experience.
If you’ve never taken out a loan before, you may see a lot of jargon thrown into the deal. It’s not uncommon to feel overwhelmed with all of the technical terms being used.
To help simplify the process for you, here’s a list of car loan terms explained. Hopefully, after reading through, you feel a little more confident and can get your car financed knowing exactly what you’re signing up for.
Starting from the beginning, there are some basic terms in a car loan that it’s always handy to know. Here are a few of them:
Borrowing power is a measure of how much money the lender would be willing to loan you.
This is calculated from your income, expenses and any current debts. Borrowing power can also take into account any collateral used (see below).
Three terms that you’re very likely to come across with any car loan.
An agreement is a legally binding contract between you and the lender. It will include all the details of your loan and can also be called a loan contract.
This will include your schedule of payments, interest, fees and other charges.
Your rights will be included in a PDS as required by Australian law.
A deposit is an initial payment you make to start the loan.
Paying a larger deposit often leads to lower monthly payments and generally means you need to borrow less money. Deposits are unlikely to be refunded if the agreement is cancelled so keep this in mind if you’re paying a large deposit upfront.
Your principal is the amount of money that is being lent to you. This will not include your deposit or the trade-in value of your current car.
Lenders make their money by charging interest. This is usually a percentage of the loan that you pay on top of the amount of credit.
There are two types of interest rate: fixed and variable. A fixed rate will not change throughout your loan, so you know exactly what your payments will be. A variable rate can change depending on the market. This can go up or down, meaning you can’t know for sure if it’s a better option than a fixed rate before you sign up.
These are any additional charges on top of your loan. They may include establishment fees for opening a loan, administration or account-keeping fees for the ongoing organisation or any other type of fee.
The total amount payable includes all of your outgoings and represents the full cost of financing your car.
It will include the amount of credit, the deposit and any interest or fees. Generally, this will be higher than the cost of the car if you had bought it outright.
Settlement is the amount you would need to pay off your loan entirely. As you make your repayments this number should go down.
The term length is simply the amount of time you will be paying back the loan.
As a general rule of thumb, car loans with shorter term lengths will have higher regular repayments, but those with longer term lengths will cost more overall as you’ll be charged more interest.
Now that we’ve got the basic stuff out of the way, here are some other car loan terms you may see when making your application.
Sometimes approval of a loan can come with conditions. This can give you a good idea of how much you can borrow and can speed up the processing time.
By getting pre-approval, you can look around car yards with a good understanding of your budget. Once you find something you like, you can make an offer with the condition of your loan being formally approved.
Cars generally lose value over time, which is called depreciation.
The first year will often see sharp depreciation and it will usually slow down by the third year. Second hand cars generally depreciate a lot more slowly.
Equity is the difference between the amount you owe to your lender and the market value of the car.
Equity can be a negative or a positive number. Negative equity can result in you paying more than the car is worth if you are trying to pay it off quickly.
A large final payment that gives you full ownership of the car. It’s often based on the predicted value of the car at the end of the agreement and if you decide not to pay it you return the car and get your deposit back. You may also trade it in for another car.
Not all agreements will have a balloon payment option but it’s important to understand if yours does as it can come as a shock if you weren’t expecting it.
Also known as salary sacrificing, a novated lease uses part of your pre-tax salary to make your repayments.
It can result in your taxable income being lower and may mean you pay less tax. However, if you want to apply for another loan (such as home loan or credit card), this may impact your borrowing power.
This type of loan will often include a balloon payment at the end.
Car loans come in two main styles: secured and unsecured.
A loan is considered secure if there is collateral or security. For car loans, the car you’re buying will often be used. If you don’t fulfil the obligations of your loan, the lender can take the collateral to cover their losses.
Unsecured loans use no collateral, but generally have higher interest rates.
Some lenders will charge a penalty fee if you chose to pay off your loan early. This can be the full amount or by making early repayments ahead of schedule. They do this because they are losing out on interest payments.
Not all lenders use this so make sure you do your homework if you want more flexibility.
A loan’s APR is a representation of the yearly cost of a loan based on the interest rate and extra fees. It is a simple way to compare loans – a lower percentage will generally mean you pay less for your loan. An APR can be either fixed or variable.
Buying a car can be a complicated process but if you understand your contract and make sure you can make your repayments it can allow you to finance your next car. Understanding common car loan terms can make this step of the journey a lot easier to navigate.
Dan, a former Australian jetski champion is passionate about helping various organisations and has held various volunteer and executive positions with several non profit organisations in Australia.