What Does Financing a Car Mean: Terms Explained

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 standard car finance terms to make it a little less intimidating to buy a new or used car.

Cashback

A cashback deal is a type of manufacturer gift, or rebate, to encourage new car shoppers to buy a vehicle. Cashback deals are usually available to shoppers paying with cash or those who secure financing through the dealership. For example, if the manufacturer’s suggested retail price is $32,000 but the manufacturer offers $2,000 cash back, that means the buyer will pay $30,000. Buyers can choose to use the cash to help with the down payment.

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 Honda is worth $12,000, you have $2,000 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 (which is explained in further detail below).

Finance

When you finance a car, you take out a loan and pay interest on it to buy the vehicle. At the end of the loan period, you own the vehicle. Typically, people will settle for a down payment of around 20% of the vehicle’s MSRP and finance the rest. New car financing is different from leasing, which is more like renting since you return the car to the dealership at the end of the lease if you don’t purchase at the agreed-upon price. Read more about leasing.

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 ratings receive a lower interest rate, while those with poor credit get higher. This means shoppers with bad credit will pay the same down payment but have a higher monthly fee since it’s riskier for banks to lend money to them.

READ RELATED STORIES: Car Finance 101: Everything You Need to Know

Money down

Money down or down payment gets used in car financing and leasing. It refers to the amount of money you can spend upfront. Think of it this way: If the Jeep you want to buy costs $10,000, and you can only spend $1,000 now, then the $1,000 is your money down. You will pay the remaining $9,000 plus interest throughout the loan period.

Principal

The principal is the amount you owe on a car loan before interest. For instance, if you put $15,000 down on a Volvo and the car costs $60,000, then your loan’s principal is $45,000.

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 cashback, 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 and asking the dealership to incorporate it into the deal to buy a 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, so you’ll need to spend extra money to get your new vehicle.

Upside down

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