Car Buyer Labs

Car Buying Advice, Tips, and Reviews

A set of hands is shown with a fan of currency.

Auto Loans 101: Understanding Key Terminology

When you’re shopping for a car, it’s easy to get really focused on the fun parts of it: looking at different vehicles, going for test drives, and picturing yourself enjoying a vehicle for many years to come. All of that stuff is great and important, but just as important is considering the financing you’ll need and how that will affect your life. It’s not enough to look for a dealership that offers auto loans near you and just accept whatever they offer you. Doing a little research and work can help you find the best terms and ultimately save you some serious money.

Today, to help with this, I’m going to take you through some of the most common words and phrases that you’ll encounter when figuring out an auto loan. Finding the best loan by comparing different options is a subject in and of itself, but we’re going to get a baseline here by making sure you know what different terminology means. Financing is often buried under layers of complex and potentially confusing language – by arming yourself with a little knowledge, you’ll be able to cut through that and understand everything that’s going on.

The Parties Involved

  • Borrower – In an auto loan, this is the person receiving the money for a vehicle – also called a “lendee.” In other words, this is you.
  • Lender – The institution providing a loan, often a bank or other financial organization.

A salesman is shown holding paperwork while standing in front of a vehicle after searching 'auto loans near you'.

Basic Loan Terms

  • Amortization – Although this word seems a bit intense, all it refers to is the repayment of a debt over a set schedule making regular payments. In other words, it refers to any auto loan where you agree to pay X amount every month for Y number of months.
  • Asset – This refers to property or anything else the borrower owns that could be potentially used for repayment of the loan. If you have another vehicle that you could sell to pay off a loan, for example, then that would be an asset.
  • Cosigner – This is someone who’s not directly receiving a loan, but they put their name on the agreement as another party responsible for the loan. A cosigner with good credit can help someone with bad credit get better terms – but if the borrower fails to pay, then the cosigner is also affected and responsible for making the payments.
  • Debt-to-Income Ratio – This is a comparison of a borrower’s income and how much they owe in loans or are paying toward a debt. To get the best terms on a loan, you want to have a very low debt-to-income ratio because it shows you’re in a good position to pay off what you borrow.
  • Equity – This is the difference between the value of the vehicle and the balance owed on a loan. “Negative equity” means the amount owed is greater than the vehicle is worth, while “positive equity” means the vehicle is worth more than what is still owed on the loan.
  • Finance Charge – This indicates the total amount of interest that’ll be paid over the lifetime of the loan.
  • Gross Monthly Income – This refers to how much a person earns each month before any expenses, including taxes, are taken out. It’s often used to determine things like the debt-to-income ratio.
  • Interest Rate – The percentage of the principal that is charged extra for the loan, which is how lenders make a profit off a loan.
  • Loan-to-Value Ratio – This is the difference between the amount of a loan and the value of a vehicle, shown as a percentage. It’s typically used in the initial terms of a loan, and afterward, you’ll see people talk about “equity” more often.
  • Net Effective Income – This is how much a person earns in a month or year after all regular deductions are considered, such as taxes.
  • Payment-to-Income Ratio – This is the percentage of a borrower’s income that is used up in paying off a loan. Someone making $1,000 each month with a $250 monthly loan payment would have a payment-to-income ratio of 25%.
  • Principal – The starting amount being borrowed on an auto loan, not including the interest.
  • Proof of Income – This is evidence of income earned by a potential borrower, typically a pay stub or similar document.
  • Proof of Residence – This is evidence that a borrower is a resident of a particular city, country, or area. Usually an official ID card such as a driver’s license or a utility bill with the borrower’s home address on it.
  • Term – This refers to the period of time a loan will be repaid.

Credit Terminology

  • Bad Credit – This term is used to indicate when someone has a low credit score – sometimes also called poor credit. The conditions of a loan to someone with bad credit are typically worse than for someone with good credit.
  • Collateral – These are any assets that the borrower of a loan puts on the line if they fail to repay the loan. Collateral can be seized by the lender if the borrower defaults on the loan.
  • Credit Bureau – Companies or agencies that track credit history to generate a credit score.
  • Credit History – This is a record of a person’s borrowing and repayment of loans over time.
  • Credit Score – A score generated by a credit bureau based on numerous factors, including credit history, debt-to-income ratio, and available credit. This score determines if someone has good or bad credit and greatly impacts the terms of an auto loan.

When Things Go Wrong

  • Acceleration Clause – This is a clause or condition in a loan agreement that sets a situation in which a lender is allowed to collect the entire remaining balance from the buyer. A common example would be if a certain number of payments are missed, then the lender can require the total balance to be paid.
  • Default – This refers to a borrower failing to pay on a loan. It can be a single missed payment, especially if you fail to communicate with the lender, or several missed payments. You want to avoid defaulting on a loan whenever possible, as it will severely harm your credit score.
  • Delinquency – This means a borrower is late in making a payment. Depending on the terms of an agreement, several days of delinquency might be allowed with a penalty fee. Delinquency often results in defaulting on a loan after a certain amount of time.
  • Lien – This is the right that a lender has to sell a vehicle in order to recover the value of a loan. It doesn’t mean the lender owns the vehicle, but they have the right to seize it and sell it if a borrower defaults on a loan.

Car Shopping Terms

  • Agreement of Sale – This is the document that you’ll ultimately sign when you buy a vehicle. Also called a “Bill of Sale” or “Purchase Agreement,” it’s the thing you want to read very carefully and make sure you understand everything detailed in it.
  • Black Book – This is a reference book (not necessarily a physical book, usually websites are used these days) for determining the value of a vehicle. It can be specific to a region, such as the Canadian Black Book, and some say Blue Book (Kelley Blue Book is often used in the US).
  • Down Payment – This is the amount of money paid on a vehicle upfront, reducing the amount of any needed loan.
  • Invoice Price – The amount that a dealership pays a manufacturer for a new vehicle.
  • Mark-Up – The difference between the invoice price and the price a dealership is asking for.
  • MSRP – The Manufacturer’s Suggested Retail Price, also called a “sticker price,” is the price the manufacturer says a vehicle should be sold at.
  • Title – The title is the document that shows ownership of a vehicle provided by the transportation agency or ministry in a particular state or province.
  • Trade-In Value – This is the value of a vehicle owned by someone who is buying a car and offering that vehicle to the dealership in trade. The greater the trade-in value, the less you’ll need to pay on your next vehicle.

Two people are shown shaking hands and exchanging keys over some paperwork.

You’re in Control

I know that was a lot, but these terms are important and mostly not too difficult to get a handle on. Once you know what they all mean, then you’ll be able to easily understand the terms and conditions of any loan and agreement of sale that you’re presented with. Just be sure to take your time, read everything carefully, and know what you’re agreeing to.