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Car Buying

New Car Financing Terms Explained

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author photo by Doug DeMuro May 2013

We all know buying a new car can be intimidating. That's especially true if you don't know all the complicated terms used in new car financing and leasing. So we've prepared a list of common car finance terms to make it a little less intimidating to buy a new or used car.

Cash back

A cash back deal is a type of manufacturer gift, or rebate, to encourage shoppers to buy a car. Cash back deals are usually available to shoppers paying with cash or those who secured financing through a bank. For example, a carmaker may ask $32,000 for a certain car but offer $2,000 cash back. That means the actual price is $30,000.

Depreciation

When a car loses value, it's called depreciation. Think of it like this: A brand-new Mercedes that was $80,000 several years ago may be worth only $25,000 today. That means it depreciated $55,000 or, put another way, it lost $55,000 in value.

Equity

Equity is the difference between what you owe and what your car is worth. If you owe $10,000 and your car is worth $12,000, you have $2,000 in equity. If you owe $10,000 and your car is worth $8,000, you have $2,000 in negative equity. Negative equity is also called being upside down.

Finance

When you finance a car, you borrow money to buy the car. At the end of the loan, you own the car. New car financing is different from leasing, which is more like renting, since you return the car at the end of the lease.

Interest rate

Banks charge a fee to anyone who borrows money. That fee is called interest, and it's usually included every month when you make a car payment. The interest rate determines just how much that fee will be. Many dealers and banks call the interest rate APR, which stands for annual percentage rate. Shoppers with good credit get a lower interest rate, while those with worse credit get a higher one. That means shoppers with worse credit usually pay a higher fee, since it's riskier for banks to lend money to them.

Money down

Money down or down payment is a term that can be used in both financing and leasing. It refers to the amount of money you can spend up front. Think of it this way: If the car costs $10,000 and you can spend $1,000 now and pay off the rest later, then that $1,000 is your money down.

Principal

The principal is the amount you owe on a car loan before interest. For instance, if your down payment is $1,000 and the car costs $10,000, then your loan's principal is $9,000.

Rebate

Sometimes car companies give shoppers a financial "gift" to encourage them to buy a car. Such a gift usually comes in the form of cash back, zero down or a low interest rate. That's called a rebate or an incentive, and it often varies monthly based on supply and demand.

Term

Term is an easy one, as it simply refers to the length of the loan. For instance, if you're getting a 60-month car loan, your loan term is 60 months, or five years. Shoppers willing to pay off cars in shorter terms often get better interest rates, but a shorter term results in a higher monthly payment.

Trade-In

If you're giving up your old car to get your new one, that means you're trading it in. In most cases, your trade-in won't be worth as much as your new car, which means you'll have to spend extra money to get your new car.

Upside down

When banks or dealers say a customer is upside down, that means the customer owes more on a car than it's worth. This is possibly because a customer might owe the car's entire value plus some interest. Many drivers are upside down in cars several years into their loans, since cars can lose value quickly.

This image is a stock photo and is not an exact representation of any vehicle offered for sale. Advertised vehicles of this model may have styling, trim levels, colors and optional equipment that differ from the stock photo.
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New Car Financing Terms Explained - Autotrader