Car finance jargon buster: key terms you need to know

There are lots of acronyms and industry terms that come with car finance. And understanding what it all means can be confusing when you haven’t come across these phrases before. 

But, it’s really important to understand what they all mean if you’re considering taking out a car loan, so we’re here to help clear them up for you. We’ve detailed key car finance jargon you’ll come across, breaking them down into simple terms!

APR (Annual Percentage Rate)

APR stands for Annual Percentage Rate. It's the total cost of borrowing money, including both the interest and any extra fees added to the loan. The APR gives you an idea of how much the loan will cost each year, helping you compare different finance offers. A lower APR means you'll pay less in interest overall, so it’s always worth keeping an eye on when choosing a deal.

Please be aware that the APR is determined by your credit profile and the lender’s terms.

Balloon Payment

 A balloon payment is a large lump sum due at the end of your PCP car finance agreement. The amount is based on the Guaranteed Future Value (GFV) of the car, which is an estimate of what the car will be worth at the end of your contract. 

You can choose to pay this amount and own the car, return it, or trade it in. The benefit of a balloon payment is that it allows for lower monthly payments throughout the contract, but you’ll need to be prepared for the large final payment if you want to keep the car.

Your lender will provide the exact amount of the balloon payment, which may vary depending on the car's condition and mileage at the end of the agreement.

Depreciation

Depreciation refers to how cars lose value over time. As soon as you buy a car, it starts losing value, and the rate at which it depreciates depends on factors like age, mileage, and condition. It can also depend on the make and model you choose. 

Depreciation is important in car finance because it can affect how much the car is worth at the end of your agreement, especially if you’re looking at options like PCP where the car’s value impacts the balloon payment. Please note that depreciation may not align with the Guaranteed Future Value (GFV) set by your lender.

Equity (Positive and Negative)

Equity refers to the difference between your car’s current value and what you owe on it. Positive equity means the car is worth more than the amount you still owe. Negative equity happens when your car is worth less than the remaining balance on your finance agreement. 

This could be an issue if you want to trade in the car early or if you have to pay off the difference to clear the loan. Be mindful that if you have negative equity, it may impact your ability to refinance or get a new finance agreement.

Excess Mileage

Excess mileage refers to driving more miles than the limit agreed upon in your finance contract. Many finance agreements, especially PCP deals, have a mileage cap, and if you go over the agreed amount, you’ll usually face additional charges. These fees can add up, so it's important to consider how many miles you plan to drive before agreeing to a deal.

Excess mileage charges are set out in your agreement, and may vary depending on the specific terms of your contract.

Fair Wear and Tear

Fair wear and tear means the normal damage that occurs as a result of everyday use. At the end of your finance agreement, you’ll be expected to return the car in a condition that reflects this kind of wear. However, if there’s damage beyond what’s considered fair, like large scratches or dents, you may face extra charges if you give the car back.

Your lender may provide specific guidelines on what constitutes fair wear and tear, and you should check these carefully.

Fixed Rate

A fixed rate means the interest rate on your car finance loan stays the same throughout your loan term. This gives you the benefit of predictable monthly payments, making it easier to budget. A fixed rate doesn’t change, even if interest rates in the wider economy go up or down.

Remember that a fixed rate loan ensures stability in repayments, but it’s important to review the total cost of the loan over time, including all associated charges.

Flat Rate

A flat rate means the interest you pay is the same amount every year, based on the original loan amount. It doesn’t decrease even when you’ve paid some of your loan off. A flat rate often looks lower than a fixed rate, but you might end up actually paying more interest overall. You should check the APR for a clearer picture of the loan's true cost.

Guaranteed Future Value (GFV)

The guaranteed future value, aka GFV, is the estimated value of your car set by the lender in a PCP deal. It’s the amount you’ll need to pay if you want to keep the car at the end of the agreement. The GFV is subject to the car’s condition, mileage, and market conditions at the time of the balloon payment.

This is important to know because it helps set the balloon payment. If the car’s actual value is less than the GFV, you may owe more than it’s worth, and you’ll be in negative equity. If it’s worth more, you will have positive equity.

Refinance

Refinancing a car means taking out a new loan to replace your existing car finance agreement. This could help lower your monthly payments or get you a better deal. For example, if interest rates have improved or you have a better credit rating. However, refinancing may not always result in better terms and spreading your monthly payments over a longer term could mean you end up paying more overall. Always check the full cost of refinancing with your lender.

Residual Value

Residual value is the estimated market value of a car at the end of a finance agreement, based on depreciation. Unlike GFV (Guaranteed Future Value) in a PCP deal, which is a pre-agreed figure set by the lender, residual value can fluctuate. Whether your car’s actual residual value is more or less than the GFV determines if you have positive or negative equity.

Part Exchange

Part exchange is when you trade in your car as part of the payment for a new one. The value of your old car is then used as a deposit or payment towards the cost of the new car. This could be a great way to reduce the amount you need to borrow, but it’s important to get a fair valuation for your car to ensure you're getting a fair deal.

When part exchanging, ensure the value of your car is fairly assessed, as it may affect your finance agreement and total loan amount.

Car finance jargon can feel complicated, but it doesn’t need to be. By understanding some of the more complex terms, you'll be better able to choose the right option for you. Don’t hesitate to ask your dedicated account manager or lender if you’re not sure on any terms; it's important to understand in full before you make any agreements.

Remember, all loans are subject to eligibility checks and may require credit approval. The terms and conditions of your finance agreement will vary depending on your individual circumstances and the lender’s criteria.

Disclaimer: The information provided in this guide is for general informational purposes only and does not constitute financial advice. All car finance agreements are subject to eligibility checks, approval, and the specific terms and conditions set by the lender. The details provided here are intended to help you understand common car finance terminology, but we recommend you speak to a qualified financial advisor or lender to discuss your specific circumstances and ensure you make an informed decision. Lenders may offer different terms depending on factors such as credit history, income, and vehicle choice. Please review the terms and conditions of any finance agreement carefully before proceeding.