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Car Loan Terminology Guide

Car Loan Terminology Guide

Buying a new or used car is one of the biggest purchases many people will make in their lifetime. With so many options and terms to understand, the process can quickly become overwhelming for even the savviest shopper. This comprehensive guide breaks down the most common auto loan key terms you need to know so you can navigate the vehicle buying and financing process wisely.


Whether you’re taking out a new car loan, used car loan, or refinancing an existing auto loan, understanding the terminology is critical. With this auto loan glossary, you’ll learn key industry terms related to interest rates, monthly payments, fees, loan length, and more. Arm yourself with this knowledge so you can compare loan offers skillfully and get the best possible deal.


Read on for plain English explanations of auto financing lingo. With this guide, you’ll be a car loan terminology expert in no time.

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What is an Auto Loan?

An auto loan is a type of secured loan used to finance the purchase of a new or used car. With an auto loan, you borrow money from a lender like a bank, credit union or other financial institution to cover all or part of the vehicle’s cost. The lender then holds a lien on the car’s title until the loan is fully repaid.

There are a few main types of auto loans:

 

  • New Car Loans – Financing for brand new vehicles purchased from a dealership
  • Used Car Loans – Financing for pre-owned vehicles purchased from a dealer or private party
  • Refinancing – Taking out a new loan to replace an existing auto loan, ideally at a lower interest rate

 

The two primary parties in an auto loan agreement are:

 

  • Lender – The financial institution or lender providing the loan funds
  • Borrower – The individual taking out the loan to purchase the vehicle

 

By understanding what an auto loan is, the different types available, and the key parties involved, you can be better prepared when financing a car purchase.

 

Annual Percentage Rate (APR)

The annual percentage rate, or APR, is one of the most important numbers to understand when taking out an auto loan. The APR represents the total cost of borrowing money for your vehicle, including interest charges and fees. It is expressed as a yearly percentage rate.

The APR takes into account not just the interest rate, but also any upfront fees or costs charged by the lender. This includes origination fees, documentation fees, or any other charges associated with processing the loan. By law, lenders are required to disclose the APR to give you the full picture of the loan’s costs.

There are several key factors that affect what APR a lender will offer on an auto loan:

 

  • Your credit score and history – Borrowers with higher credit scores tend to qualify for lower APRs.
  • The loan term – Shorter loan terms often have lower APRs.
  • Type of vehicle – New cars tend to have lower APRs than used cars.
  • Down payment amount – A higher down payment reduces the risk for lenders and can result in a lower APR.
  • Market interest rates – APRs tend to rise when market rates go up.

 

When comparing loan offers from different lenders, be sure to look at the APRs. A difference of even 1% in APRs can add hundreds or thousands of dollars in extra costs over the life of your loan. Always compare the APR first before any other terms when rate shopping for the best auto loan.

 

Loan Term

The loan term refers to the length of time you have to repay the auto loan. It is typically expressed in months, with most auto loans ranging from 24 to 84 months in duration. When selecting a loan term, there are several key factors to consider:

 

Timeframe for Repayment

Shorter loan terms like 24-36 months mean you will pay off the loan more quickly, but your monthly payments will be higher. Longer terms of 72-84 months have lower monthly payments but take longer to pay off and accrue more interest.

 

Pros of Shorter Loan Terms

 

 

Cons of Shorter Loan Terms

 

  • Higher monthly payments
  • May be difficult to fit in budget

 

Pros of Longer Loan Terms

 

  • Lower monthly payments
  • Easier to manage with budget

 

Cons of Longer Loan Terms

 

  • More interest paid over life of loan
  • Take longer to build equity
  • Higher risk of owing more than car is worth

 

Impact on Monthly Payments

The loan term directly impacts your monthly payment. Shorter terms mean higher payments, longer terms mean lower payments. Make sure to select a term that fits your budget to avoid financial stress. Use an auto loan calculator to estimate payments for different loan terms.

 

Down Payment

A down payment refers to the amount of money you pay upfront towards the total cost of the vehicle when financing a car purchase. It is paid directly to the dealership at the time of sale to lower the amount you need to borrow.

Down payment amounts typically range from 0% to 20% of the vehicle’s purchase price. Putting down a larger down payment reduces the loan amount you have to borrow and can help get approved for financing more easily. It also leads to lower monthly payments.

Experts often recommend putting down at least 10-20% if you can. This shows lenders you are financially committed to the purchase. Minimum down payments vary by lender but can be as low as $0 or 1-3% for those with excellent credit.

The down payment directly impacts how much you need to finance. For example on a $20,000 vehicle:

 

  • 10% down = $2,000 down payment. $18,000 financed
  • 15% down = $3,000 down payment. $17,000 financed
  • 20% down = $4,000 down payment. $16,000 financed

 

With a larger down payment, you borrow less so you pay less interest charges over the loan term. This saves money over time.

 

Total Interest Paid

Total interest paid is the full amount of interest charges you pay over the entire life of the auto loan. It’s calculated based on the loan amount, APR, and length of the loan term.

When comparing auto loan offers, look closely at the total interest paid, not just the monthly payment. One loan may have a lower monthly cost but a higher total interest expense in the long run.

For example:

 

  • Loan 1: $20,000 over 60 months at 5% APR would have monthly payments of $368 and total interest paid of $2,080.
  • Loan 2: $20,000 over 72 months at 7% APR would have monthly payments of $331 but total interest paid of $3,132.

 

Even though the monthly payment is lower for Loan 2, the total interest paid is much higher. Be sure to calculate and compare total interest costs when evaluating loans.

 

Residual Value

The residual value refers to the estimated value of the vehicle at the end of the auto loan term. When you take out a car loan, the lender calculates the vehicle’s residual value to help determine the amount you can borrow.

The residual value is an important factor because it impacts how much depreciation you will be responsible for paying off during the loan term. Vehicles depreciate quickly in the first years of ownership. With a lower residual value, you may end up owing more than the car is worth if you want to trade it in or sell it before repaying the loan in full.

Here are some of the key factors that affect a vehicle’s residual value:

 

  • Make and model – Luxury and high-demand vehicles typically have better residual values.
  • Mileage – The more miles driven, the lower the residual value.
  • Condition and maintenance – Poor condition or lack of maintenance reduces residual value.
  • Age – Newer model years have better residual values.
  • Market factors – Strong used car demand increases residual values.

 

Getting an accurate residual value estimate helps you assess the true long-term costs of financing and owning a particular vehicle. Reviewing residual value guides and having realistic expectations of depreciation will enable you to make a wise auto loan decision.

 

Prepayment Penalties

A prepayment penalty is a fee charged by some lenders if you pay off your auto loan early. Here’s how prepayment penalties work with auto loans:

 

Definition: A prepayment penalty is an extra fee that may be charged if you pay off your auto loan before the end of the loan term. Not all lenders charge this fee.

How They Work: With a prepayment penalty, you typically have to pay a percentage of the remaining loan balance if you pay off the loan early. For example, if you have 2 years left on your auto loan and pay it off now, you may have to pay 1% of the remaining balance as a penalty. The specifics vary by lender.

Some lenders charge prepayment penalties to discourage early repayment and ensure they earn interest over the full loan term. It helps them forecast expected earnings from interest payments.

Many people are not aware of prepayment penalties when they sign their auto loan. It’s important to ask the lender if they charge this fee before signing your loan agreement.

Alternatives: Not all lenders charge prepayment penalties. Many have loans without this fee. Shopping around for the best rates and terms can help you avoid prepayment penalties.

Strategies: If you may pay off your loan early, try to find a lender that does not charge prepayment penalties. You can also ask the lender to remove the prepayment penalty from your loan contract before signing.

 

Co-signers

A co-signer is someone who agrees to be legally responsible for repaying the auto loan if the primary borrower defaults. Adding a co-signer to your auto loan application can help you qualify for the loan or get better terms if you have little or no credit history.

The main pros of using a co-signer are:

 

  • May help you get approved if you don’t qualify on your own
  • Can help you get lower interest rates
  • Allows you to build your own credit history by making on-time payments

 

The main cons are:

 

  • Puts responsibility for the loan on the co-signer if you can’t pay
  • Can negatively impact their credit if payments are missed
  • May strain your relationship with the co-signer

 

To qualify as a co-signer, a person typically needs to have good credit, sufficient income to cover the loan payments if needed, and be willing to accept legal responsibility for the debt. Many lenders have minimum credit score requirements for co-signers such as a FICO score of at least 660 or higher.

 

Lien Holders

A lien holder is the lender that provides the financing for your auto loan. When you finance a car, the lender places a lien on the vehicle’s title until the loan is fully repaid. This gives the lender a secured interest in the car, meaning they have the legal right to repossess it if you default on the loan.

The lien holder is listed on the vehicle title along with the owner of the car. You cannot sell or transfer ownership of the vehicle without the permission of the lien holder, since they have a financial stake in it until the loan is paid off.

As you make monthly payments on your auto loan, you are gradually paying back the money owed to the lien holder. Once the loan balance reaches zero, the lien holder will release their interest in the vehicle and send you a clear title confirming you officially own the car free and clear.

Understanding the role of the lien holder helps explain why you can’t immediately sell or trade in a financed vehicle – the lender has secured rights over it. Overall, the lien holder relationship protects the interests of both the borrower and lender in an auto loan transaction.

 

Truth in Lending Disclosures

Truth in Lending disclosures are an important part of the auto loan process. They provide key details about the loan terms to the borrower prior to signing the agreement. The purpose of Truth in Lending disclosures is to promote transparency and allow borrowers to clearly understand the costs of financing.

There are several key details disclosed through Truth in Lending:

 

  • The annual percentage rate (APR), which shows the total cost of credit including interest and fees
  • The finance charge, or total amount in dollars that the loan will cost
  • The amount financed, or the amount of credit provided to the borrower
  • The total of payments, which is the total the borrower will pay over the loan term if all payments are made on time
  • The payment schedule showing the number, timing, and amounts of payments

 

Reviewing the Truth in Lending disclosures closely allows borrowers to fully grasp the costs and terms of the loan. It’s important to understand this information before signing any auto loan agreement.

 

Other Key Terminology

Here are some other important auto loan terms to understand:

 

Residual Value

The residual value is the estimated value of the vehicle at the end of the lease or loan term. This helps determine the depreciation costs that factor into monthly payments.

 

Trade-In Value

The trade-in value is what the dealer will offer for your current vehicle if you trade it in when purchasing a new one. The trade-in amount impacts the overall loan amount.

 

Early Payoff Penalties

Some lenders charge fees or penalties for paying off a loan early. Make sure to check the fine print to avoid surprises.

 

Co-Borrowers

Co-borrowers share responsibility for repaying the auto loan. Their credit history and income are factored in by lenders.

 

Late Fees

Late fees are charged if a payment is not received by the due date. These vary by lender but are typically around $25-50 per late payment.

 

Deferment

Deferment allows you to temporarily postpone making payments, often due to financial hardship. Interest still accrues during this time in most cases.

 

Tips for Getting the Best Deal

Here are some tips for securing the most favorable loan terms when financing a vehicle purchase:

 

Shop Around

Get rate quotes from multiple lenders, including banks, credit unions, and online lenders. Rates and terms can vary significantly, so shopping around is key to finding the best deal.

 

Check Your Credit

Review your credit reports and scores before applying. Good credit will qualify you for lower interest rates. If needed, work on improving your credit first.

 

Consider a Shorter Term

Opt for a shorter loan term if possible, such as 48 or 60 months. This results in lower interest charges over the life of the loan. Your monthly payment will be higher but you’ll pay off the loan faster.

 

Make a Sizeable Down Payment

Put down as much as you can comfortably afford upfront. A 20% down payment or more will get you the best rates. It also keeps your loan amount lower, reducing the total interest paid.

 

Look for Special Offers

Some lenders provide discounts for new customers, recent college grads, loyalty members, or pre-approval. Ask about any special financing offers that may be available.

 

Consider a Co-signer

Adding a creditworthy co-signer with good credit may help you qualify for more favorable terms. But be cautious, as they take on equal responsibility for the loan.

 

Conclusion

Understanding common auto loan terminology is key to getting the best financing deal. This guide has broken down all the key terms to know when shopping for a car loan, so you can compare offers wisely.

The main takeaways are:

 

  • Compare APRs across lenders to find the lowest total cost of borrowing.
  • Select a loan term that fits your budget – longer terms have lower payments but higher interest.
  • Put down a 20% down payment if possible to get the best rates and avoid being underwater.
  • Watch out for prepayment penalties that make it expensive to pay off a loan early.
  • Add a cosigner or put down a larger down payment if you have little credit history.
  • Review the Truth in Lending disclosures to understand the full terms of any loan offer.

 

Armed with this knowledge, you can shop confidently, compare all the numbers, and select the most favorable auto loan for your situation. Taking the time to research before committing to a loan will ensure you get the ideal financing at the best possible rate.

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Questions About Car Loan Terminology

Annual Percentage Rate (APR) is the total cost of your loan expressed as an annual rate. It includes the interest you pay plus any other charges or fees. A lower APR usually means a better deal on your car loan. In Canada, new car loans typically have APRs between 0-10%, while used cars are higher from 5-20%.

Current average interest rates on new car loans range from 4.99% to 11.99% for terms of 2-8 years. For used cars, rates range from 6.99% to 15.99% depending on factors like your credit score. Prime borrowers with scores over 720 can qualify for rates as low as 0-4.99% on new and 1-5.99% on used.



The average monthly car payment in Canada is $521 for new vehicles and $397 for used vehicles. With a 5-year loan term and average interest rate, you would pay about $527 per month for a $30,000 new car, or $397 for a $20,000 used model. Longer terms reduce the payment but increase total interest paid.

The most popular loan terms in Canada are 60 months (5 years) and 72 months (6 years). 84-month terms are becoming more common, allowing lower monthly payments but with higher total interest costs. 36 and 48-month loans have less interest, but require higher monthly payments on the same principal.

Experts recommend choosing the shortest term you can afford, even if it means a higher monthly payment. Aim for a 36 or 48-month term if possible. Not only will you pay less interest with a shorter term, but you’ll save on auto insurance since premiums are based partly on the car’s value – which declines each year.

Financial experts caution not to spend more than 10-15% of your total take-home income on auto loan payments. This includes the loan payment, insurance, gas and maintenance. If your net monthly income is $4,000, you can afford a monthly car payment of about $400-600. Go higher at your own risk.

To get the lowest interest rates in Canada, you generally need very good to excellent credit, with FICO scores of 720 or higher. This qualifies you for “prime” loan rates from 0-5% on new cars and 1-7% for used models. Subprime borrowers with scores below 600 will pay significantly higher rates.

Typical documents required for a Canadian auto loan are: valid driver’s license, proof of income (pay stubs or tax return), proof of address, list of references, proof of auto insurance, down payment, and the vehicle’s make, model, year and VIN number. Lenders also check credit reports.

Yes, new immigrants and foreign workers can qualify for a Canadian auto loan even with minimal credit history. Many lenders use alternative credit data, so foreign credit reports, rent payments, utility bills, etc can demonstrate creditworthiness. A larger down payment also helps secure financing.



If you have bad credit (scores below 600), you can still get approved but will pay higher interest rates. Expect rates from 8-25%. Lenders will require a larger down payment, from 20-50% of the car’s value. You also need steady income and to show you can afford the monthly payments.

With very bad credit (below 550 FICO), most Canadian lenders will limit auto loans to a maximum of $10,000 – $15,000. This lower cap helps reduce their risk. Borrowers with credit scores in the 550-599 range may qualify for loans up to $20,000. Higher amounts are available with scores above 600.

Yes, you can get a car loan in Canada after bankruptcy or a consumer proposal discharge. However, you’ll need to re-establish your credit first. Most lenders will want to see at least 12 months of clean credit with no late payments or collections after your insolvency. Interest rates will also be higher.

The keys to getting the lowest rates are having excellent credit (720+ scores), a large down payment (20% or more), choosing a shorter loan term (3 years), having stable income, and shopping around for quotes from multiple lenders. Also look for promotions directly from the car manufacturer.

Yes, getting pre-approved by your bank or credit union before shopping gives you a bargaining chip to negotiate the best deal. The pre-approval letter shows the dealer you are a serious buyer and locks in an interest rate. Just don’t reveal the rate or term, so the dealer can try to beat your existing loan offer.

Be wary of these common fees Canadian car dealers may try to tack on to loans: documentation fees ($300+), credit insurance, extended warranties, etching, nitrogen-filled tires, etc. These extras boost their profits but are rarely worth the cost for buyers. Refuse them or negotiate fees off the vehicle price instead.

One proven way to save hundreds in interest is making your auto loan payments every 2 weeks instead of monthly. This adds an extra monthly principal payment each year, allowing you to pay the loan off faster. Even better is weekly payments. Just be sure your lender doesn’t charge fees for higher payment frequencies.

Unless your interest rate exceeds 7-8%, most experts recommend investing spare cash rather than prepaying low-rate auto loans. For example, stocks historically return 10% yearly, while a 3% car loan costs little in interest. Pay the minimum monthly payment and invest extra amounts for better long term returns.

Mandatory loan requirements in Canada include allowing the borrower to cancel within 2 business days, disclosing the APR and total borrowing costs, providing regular account statements, allowing payoff without penalty, and limiting liability for unauthorized use of stolen vehicles. These protect consumers from unfair lending practices.

The cheapest rates on auto loans typically come from online lenders, credit unions, banks, and manufacturer captive finance companies – in that order. Websites like RateHub.ca let you easily compare quotes from over 10 of these national lending sources to find the lowest rate for your particular situation.

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