All the Car Terms You Need to Know When Buying a Car
An acceleration clause is a provision in a loan contract that allows the lender to require the borrower to pay off the rest of the loan (the “outstanding balance”) before the termends under certain circumstances. The contract explains what those circumstances are.
One common reason that lenders would accelerate (or speed up) repayment is if the borrower misses too many payments or makes too many late (“delinquent”) payments.
Adverse action notice
Federal law requires creditors to send applicants an official notice if they deny credit based on information in the applicant’s credit report.
That notice must include the name, address, and phone number of the credit reporting agency that the creditor used in making their credit decision and inform the applicant of their right to obtain their credit report and to dispute any inaccuracies.
In Latin, “mort” means death (like mortuary or immortal, or even Voldemort). So what does that have to do with car loans? Amortizing is a finance term which means to “kill” the loan off over time with installment payments. Some percent of the payments a borrower makes each month go toward paying off the principal balance, with the rest allocated to interest.
Most loans are structured so that the borrower pays more in interest first, and only pays down the principal toward the end of the loan term. An amortization schedule shows exactly how much the borrower pays in principal and interest each month. Use our car loan amortization schedule to learn more!
The amount financed means the total amount you’re borrowing to buy your vehicle and any related products. It includes the cost of the vehicle you’re getting the loan for (minus down payment, trade-in allowance, and any incentives or rebates), plus any other costs and fees you’re paying for with the loan (like taxes, title, registration fees, and any ancillary products).
It’s helpful to think of the amount financed as equal to the price you’d pay if you were buying your vehicle with cash because it doesn’t include the cost to borrow money (“finance charges”), including interest and loan fees.
Ancillary products are any extra products you can buy with your vehicle. The most common ones are Vehicle Service Contracts, GAP Waiver policies, Tire & Wheel, and Dent & Ding.
Lenders will often allow you to pay for the products with your loan. (For our take on which products are valuable and which ones are a waste, check out Four to Get, Five to Forget).
Annual Percentage Rate (APR)
Sometimes known as the contract rate, the APR is the average amount of interest you’ll pay each year for your loan. It’s not the same as the interest rate because the APR includes lender fees and other costs to borrow money, and the interest rate does not. That’s why the APR is higher than the interest rate for the same loan. Because it’s more comprehensive, the APR is a better way to compare between loan offers.
For example, imagine two lenders each offer a $10K loan at a 6% interest rate for 60 months. Lender A charges $1,000 in financing charges, and Lender B charges $500. The APR for Lender A would be 10.04%, while the APR for Lender B would be 8.05%. That’s a pretty big difference!
In a legal sense, assigning a contract means handing it to another person (or company), who takes over all of the responsibilities and benefits of the contract as if they had entered it in the first place. When it comes to auto loans, the assignee is the person or company that buys your loan.
For example, if you decide to have your dealership arrange financing for you through an indirect financing, you most likely won’t make your monthly car payments to your dealership. Instead, the dealership typically sells (or “assigns”) your contract to a bank or other financial institution. You then owe your payments to the bank, and the bank will have the right to repossess your vehicle if you don’t pay.
A balloon payment is a large payment made at the end of a loan. Usually, monthly payments are lower on a balloon loan (also known as a residual payment loan), but the risk is not being able to afford the big payment at the end. And if your vehicle doesn’t keep its value, you can’t necessarily sell or trade-in the vehicle to come up with that payment.
If you’re stuck with a balloon loan that you can’t afford, refinancing your car loan might be a good option.
The base price of a vehicle is the manufacturer’s suggested price for the lowest trim model, not including any options, destination charges, or other dealer fees. (If you add in those costs, you get the MSRP). If you hear a commercial advertising a car for a price “as low as,” chances are it’s referring to the base price.
Unlike MSRP for new cars, there’s not usually one agreed-upon price for a used car. That’s because each used car has its own unique history. For example, a 10 minute commute puts a lot less strain on a car than a 2 hour daily round-trip.
When you go to trade in or sell your vehicle, the dealer or buyer is going to need a way to figure out how much it’s worth, taking into account the year, make, model, trim, mileage, and condition.
A number of companies publish value ranges, from estimates of trade-in values to values you can use as the starting point for private party negotiations. Kelley Blue Book is probably the most well-known value estimator, but there are a number of other companies (including NADA, Black Book, and Carfax) that publish values.
Each one uses a slightly different formula to arrive at its calculations, so the values for the same vehicle can vary. The book value is the car term used for any one of those values. These same companies also frequently publish values for new cars. Those values can be different than the MSRP, typically depending on how common the vehicle is and how much demand the companies estimate there will be for it.
The book-out sheet provides all of the data that a lender needs to know about a used vehicle, including the VIN, year, make, model, trim, options and features, and mileage. It’s important to make sure that the book-out sheet accurately reflects the vehicle you’re buying.
A common scam, known as power booking, occurs when a dealer claims that the vehicle has more bells and whistles than it really does so the lender will be willing to lend more money.
The “box” is the slang term for the dealership’s Finance & Insurance (“F&I”) office, also known as the “back office.”
When a dealer receives a loan offer from a lender, it comes with an interest rate known as the buy rate. Depending on the agreement between the dealer and the lender, the dealer can then mark up or increase that rate and keep most of the difference. That new marked-up rate, known as the contract rate, is what the dealer will present to you as your interest rate. To find out a lot more about loan markups, check out the Outside Financial Markup Index.
Buydowns are basically a way of prepaying interest on a loan; the borrower pays extra money upfront to reduce the interest rate for a period of time. The loan term and principal amount stay the same. Sometimes, dealers use (undisclosed) buydowns as a tactic to make the interest rate appear low, while making up for it in charging a higher price for the vehicle, under-valuing the trade-in, or both.
A buyer’s order (also known as a purchase order or sales contract) contains all the essential details about the vehicle you’re buying, including the VIN, year, make, model, trim, sales price, taxes, dealer fees, the value of your trade-in, your down payment, and any options you’ve chosen to add on. (It does not contain any details about your loan, though, since the buyer’s order is the same whether or not you’re financing the vehicle through the dealer).
Some dealers call the same document a buyer’s order before it’s signed and a sales contract once you’ve finalized all the details. The most important thing to remember is to carefully read through each line of your buyer’s order to make sure that all of the details are exactly what you’ve agreed to; never sign a blank buyer’s order or one that contains inaccurate info.
Captive lenders, like Toyota Financial Services, Volkswagen Credit, and Hyundai Motor Finance, are the financing arms of vehicle manufacturers.
It sounds too good to be true: you get a new, better loan on your vehicle and cash to do whatever you want with. And for some borrowers, a cash-out refinance (or cash-back refi) can be a great deal.
If you have equity in your vehicle (meaning your vehicle is worth more than you owe on your loan), you might be eligible to get a new loan that will pay off your existing loan and give you cash on top of that.
Keep in mind, though, that nothing is totally free; you will eventually have to pay back the cash, with interest. Also keep in mind that not all lenders are willing to provide cash-out refinance loans, and the availability of any loan depends on your credit history.
Just like it sounds, a co-borrower (or “joint applicant”) is someone you borrow money with. When it comes to auto loans, a co-borrower is also someone you buy (and own) your vehicle with. In general, applying with a co-borrower may help increase the amount you’re able to borrow and increase your chances of being approved.
Lenders consider the ratio of the debts you owe to the income you make in order to determine how much they’re willing to lend to you. If you divide your debts by two incomes instead of one, you may be able to qualify for a better rate, or with more lenders, than if those same debts were divided by just your income. Also, many lenders merge credit scores when using a co-borrower or even use only the higher of the two scores, leading to a better loan for you.
A co-borrower is not the same as a co-signer. A co-signer is someone who agrees to pay off the loan if the primary borrower doesn’t, but the co-signer doesn’t actually own the collateral. The most common example of a co-borrower is a spouse; a co-signer is more likely to be a parent helping a teenager or young adult to establish credit.
Collateral is any property that secures a loan. When you get an auto loan, your vehicle is the collateral; if you stop repaying the loan, your lender can repossess your vehicle in order to pay off the debt.
The condition of a vehicle describes what shape a vehicle is in. Different companies that evaluate vehicle values use different grades or tiers. KBB, for example, rates vehicles in one of four conditions: excellent, good, fair, and poor. A vehicle rated as poor will be worth less than one rated excellent, even if they both have the same year, make, model, trim, and mileage.
The contract rate is the interest rate offered to you by the dealer. It’s usually higher than the buy rate, the interest rate that the lender provides to the dealer, because the dealer marks up the loan and keeps most of the difference. To find out a lot more about loan markups, check out the Outside Financial Markup Index.
Certified Pre-Owned (CPO)
Used vehicles can range from real junkers to good-as-new dream rides. Manufacturers obviously want you to pay more for the higher-quality ones, and one way of doing that is to give them a special status.
Each brand sets its own rules for CPO cars, but generally, they require the vehicle to be relatively recent (5-7 model years or younger), have a low number of miles, and pass a rigorous inspection.
The CPO vehicle will usually come with a warranty and other perks, like free roadside assistance. You’ll pay a little more for that piece of mind, but a CPO vehicle can be a good deal if you want a car that’s like new but isn’t.
Some dealers offer their own “certification,” which isn’t necessarily the same as a manufacturer’s CPO program. Make sure that you know what you’re getting before you agree to buy any vehicle.
Credit bureau (or credit reporting agency)
A credit bureau’s job is to compile information about borrowers from lenders – including credit card companies, auto lenders, and student loan companies – and then sell it back to those lenders so they can make lending decisions.
The three major credit bureaus in the U.S. are Equifax, Experian, and TransUnion. If you’ve ever opened up any credit account, chances are the big three bureaus will have a file with your name on it and your payment history in a credit report.
The Fair Credit Reporting Act (FCRA) is a federal law that regulates credit bureaus and credit reporting. The FTC provides a guide to your rights under the FCRA here
When you apply for a loan, the potential lender needs to know information about your borrowing history to determine whether to lend to you, how much, and at what rate. To do that, the lender will request your credit report and credit score from one of the credit bureaus. That request is called a credit inquiry.
Inquiries come in two flavors: hard inquiries (or “hard pulls”) or soft inquiries (“soft pulls”). Hard inquiries will be noted on your credit report and could decrease your credit score by a few points. That’s because shopping for too much credit at one time could indicate a problem.
It’s a red flag to a lender if a borrower needs a car loan, mortgage, and three new credit cards all at the same time. BUT that same logic doesn’t apply to rate-shopping for one loan. In fact, lenders know that it’s smart to compare offers, so there’s no penalty for multiple hard inquiries for the same type of loan in a short period of time.
For example, the main credit scoring company, FICO, considers all inquiries related to auto loans within a 45-day period as one single credit inquiry.
Soft pulls don’t affect your credit, and they aren’t recorded on your credit report. When you apply to be pre-qualified for an auto loan through Outside Financial, we do a soft pull of your credit on Experian. That helps us to determine whether we can match you with one of the lenders on our platform. If you request your own credit report, that would also be considered a soft pull.
Credit life insurance
A credit life policy pays off a borrower’s debts if they die. It won’t pay out to the borrower’s beneficiaries like life insurance; instead, it pays the lender directly. Although everyone’s financial situation is different, credit life insurance usually isn’t a good deal because most debts die with the borrower anyway.
A credit report is a detailed account of your credit history. Each of the three major credit bureaus (Equifax, Experian, and TransUnion) compiles its own proprietary list of your borrowing and payment record, so they can vary a little.
Each report should include the details of accounts you currently have open or recently closed, whether for revolving credit (like credit cards) or installment credit (like auto loans). Any bankruptcies, tax liens, repossessions, or foreclosures will also appear, typically for 7 years.
By law, you can access each of your credit reports for free once a year at annualcreditreport.com before applying for a loan, it’s a good idea to check your credit reports to make sure all of the information is accurate and up-to-date, because lenders typically use credit reports to make lending decisions.
One surprising thing not included on your credit report is your credit score, a number assigned to your credit history that lenders use in evaluating the risk of lending money to you.
Credit scores are a quick shorthand for a lender deciding how risky it is to lend money to a borrower. They’re essentially like a GPA for a borrower’s credit history. The higher your credit score, the better, because it means you’ve been rated as a lower risk to borrow money.
Credit scoring seems simple, but it’s actually pretty complicated. For starters, there are many different credit scoring models offered by different companies. (FICO invented the credit score and is still probably the best-known provider). Each model weights your credit history slightly differently;
For example, some models may put more importance on certain types of debt; others may weigh delinquencies higher or lower.
Although you cannot see your credit scores in your free credit report, a number of companies provide free access to credit scores. Many credit card providers, banks, and credit unions offer free scores as a perk; check out your financial service company’s website to see if they’re one of them. Discover also offers free scores, even to non-customers. Sites like Credit Karma and Nerd Wallet will also monitor your credit score.
These scores may or may not be the same that lenders use when evaluating your credit application, but they will give you some indication of your credit profile.
Most lenders divide credit scores into five different buckets or “tiers”: super-prime, prime, near- or non-prime, subprime, and deep subprime. Which scores fall into which buckets depends on the credit bureau or lender.
As an example, Experian uses the following buckets for its FICO scores:
Super-prime or exceptional: 800+
Prime or very good: 740 - 799
Near/non-prime or good: 670 – 739
Subprime or fair: 580 - 669
Deep-subprime or poor: 579 or lower
Credit unions seem like banks: they offer savings and checking accounts and lend money. But credit unions and banks aren’t the same thing. By law, credit unions are not-for-profit financial cooperatives, which means they must be managed to serve the needs of their members/owners.
Because credit unions are designed to serve their members, they often are able to offer better rates and lower fees than banks.
Credit unions are regulated by the National Credit Union Administration (NCUA), which insures credit union deposits much like the FDIC insures bank deposits. All credit unions have eligibility requirements. Some credit unions are made up of employees of a certain company; others accept anyone who lives, works, or worships in a certain community. To find a credit union near you, check out this helpful resource from NCUA.
A creditor is someone who is owed a debt by a borrower (or “debtor”). Creditors could be individuals (“Mom, can I borrow $20?”), companies (like a bank that extends an auto loan), the government or other organizations.
Dealer invoice price
The dealer invoice price, aka dealer cost or factory invoice, is the amount that the vehicle manufacturer (or OEM) supposedly wants from the dealership for a vehicle. It’s the amount that the manufacturer puts on the invoice it sends to the dealership. That doesn’t mean that the invoice price is actually what the dealer will pay to the manufacturer, however. Dealers typically get discounts, rebates, and other incentives from the manufacturer that reduce the price well below invoice.
Dealers sometimes try to convince customers they’re getting a good deal by comparing the sales price to the invoice price, so it’s important to understand that the dealership can still make a good deal of profit even if it sells a car at the invoice price. (How much profit depends on the incentives and rebates offered for that particular make and model – a very popular vehicle may have fewer incentives attached to it than one that dealers are struggling to sell).
How does dealer invoice compare to MSRP? The dealer invoice price is the amount that the manufacturer (supposedly) wants from the dealership, while the MSRP is the amount that the manufacturer (supposedly) wants the buyer to pay the dealership. The MSRP is always higher than the invoice price to allow for dealer profit.
Holdbacks are one of the ways that dealerships earn profit from selling vehicles. The manufacturer “reimburses” the dealer a certain amount (usually 2-3% of MSRP) for selling a new vehicle.
That holdback incentive is not captured in the invoice price, which is one reason that dealers are able to make money even if they claim to sell a vehicle at invoice.
Dealers can make a commission known as the markup, reserve, or finance reserve for arranging an auto loan for a car buyer. The markup is the difference between the buy rate (the interest rate that the lender offers) and the contract rate (the interest rate that the dealer offers to the customer).
Each lender sets a different limit, but markups are typically 1-2%, which means that a 5% buy rate could become a 6 or 7% contract rate. Dealers typically keep ~75% of that amount, and the lender gets the rest. To find out a lot more about loan markups, check out the Outside Financial Markup Index.
Debt-to-Income ratio (DTI)
DTI is a ratio that lenders use to determine how much to lend and at what rate. DTI is calculated by taking your total monthly debts (including your mortgage, rent, credit cards, car payments, etc.) and dividing them by your total monthly income. The lower the DTI, the better, because it means you have more income to pay off your debts.
A debtor is someone who owes a debt to a creditor. If you borrow money to buy a vehicle, you are a debtor, and the bank or credit union that loaned you the money is the creditor.
Defaulting on a loan means failing to pay it back as promised. Each lender sets consequences for defaulting differently, from taking action after one missed payment to waiting six months or longer.
Defaulting on an auto loan could lead to the lender repossessing (or taking back) the vehicle, and it will likely lead to a drop in the borrower’s credit score.
Default is used as both a noun and a verb, meaning that a borrower who defaults on a loan by not paying will be considered in default by the lender.
Delinquency means being late with making payments, even by one day. Lenders often penalize borrowers who are delinquent by charging late fees.
What’s the difference between default and delinquency? Lenders typically consider an account to be in default if the borrower doesn’t make required payments (i.e., is delinquent) for a certain period of time.
Delivery fees, sometimes called destination charges, are required by law to be listed separately on the window sticker. These fees pay for the vehicle to be transported from the factory to your dealer’s showroom.
Even if you live close to the factory, though, manufacturers standardize their changes, so your delivery fee won’t be any lower than if you lived across the country. Although delivery fees are not optional or negotiable, dealers do sometimes try to tack on additional “delivery” fees, so make sure to check the official window sticker for the exact amount.
Dent & Ding
Dings are small blemishes on the outside of your car, the kind caused by run-away shopping carts or that guy who parked too close and flung his door right into yours. Dents are more major damages that may require repainting or even replacing the part of the car that has been dented.
Both can make your vehicle a lot less pretty – and reduce its resale value. Dent & Ding protection is designed to cover repairs and replacements. The F&I manager will typically try to sell Dent & Ding protection, along with other ancillary products, at the time of purchase.
At Outside Financial, we think Dent & Ding protection can be a good investment, if you get it at the right price and you understand what’s covered in your policy.
Unless you’re talking about a classic car, most vehicles lose value over time. That decrease in value is called depreciation. How fast any particular vehicle’s value goes down depends on a lot of factors, including the type of car (for example, luxury cars tend to lose value more quickly). No matter what kind of vehicle you choose, the first year of a car’s life is always the worst. Just driving a new car off the lot turns it into a used car, which is worth a lot less. Edmunds offers a handy True-Cost-to-Own calculator that can help indicate how much depreciation you can expect for a given model.
Documentation fees (“doc fees” for short) are fees charged by dealerships for filling out all the paperwork. They can range from a few hundred to almost a thousand dollars depending on the dealer and where you live (Edmunds has a helpful chart that explains the allowable fees in each state). According to Consumer Reports, document fees are not negotiable; you’re better off focusing on the bottom-line or drive-away price, which includes all dealer fees.
A down payment is any money you pay upfront when you buy something on credit, like a house or a car. Making a down payment is helpful because it shows lenders you're serious about paying back your car loan. If you can afford to put money down, it also means that you are borrowing less, which means you’ll pay less in interest over the term of your loan. The standard recommendation for a car purchase is to put 20% of the purchase price down (which means you take out a loan for the remaining 80%), although how much you can put down depends on your own finances.
F&I stands for Finance and Insurance, and it refers to the part of the dealership responsible for arranging financing for the vehicles that it sells.
If you go to a dealership without financing arranged in advance, you may wind up in the F&I manager’s back office (aka “the box”) after you’ve agreed to purchase a vehicle.
Many dealerships split up responsibilities for selling the car and arranging financing for it, although sometimes the same salesperson will handle both.
Fabric protection is an ancillary product sold by many dealerships. At Outside Financial, we recommend buying a can of Scotchgard instead – it also protects the fabric seats in your vehicle, for a lot less money.
FICO, which stands for the Fair Isaac Corporation, is a data analytics company. Their claim to fame is inventing the credit scores.
FICO scores are still one of the most common ways that lenders measure credit risk. FICO offers several different models, including one geared specifically toward auto lenders called the FICO Auto Score that weights your previous history with auto loans more heavily than the “base” FICO score.
Each model has a different range; the “classic” version went from 350 to 850, but FICO’s newer NextGen scores go up to 950. Each model also uses a different formula to create the score, and each lender selects the version that works best for them. The three major credit bureaus also use their own variants.
FICO explains more about the different models available to lenders on their website
It’s helpful to think about the costs to buy a car with a loan in two buckets: one is the cost of the car itself (what you’d pay if you were buying it in cash, also known as the amount financed) and the other is the cost to borrow the money to buy that car.
The finance charge includes everything you pay for the privilege of borrowing money from a lender, including interest and loan fees.
Often the finance charges will be prepaid, or assessed at the time you take out your loan.
Firm offer of credit
Legally speaking, a firm offer of credit means any offer of credit to a consumer that will be honored if the consumer is determined to meet specific eligibility criteria. Huh? The best way to understand a firm offer is to think of all those mailers you get offering you a x.x% APR for a loan.
The company sending out those mailers has likely determined that you might be a candidate for a loan or a credit card based on a “prescreen” of your credit profile. The credit bureaus sell lists of consumers who meet certain criteria to lenders, who then market their products to the people on that list.
By law, if the lender has extended a firm offer of credit they must honor it IF the consumer passes the lender’s criteria.
Five finger close
The five finger close is a type of dealer fraud in which the dealer covers up the numbers in the sales documents with his hand so that the buyer can’t see them. The unsuspecting buyer signs off, assuming that the papers reflect the deal they made. A similar tactic, known as the “five finger fold,” is to show the buyer the first page of the sales documents and flip up the bottom so only the signature line is visible.
Some dealers now offer buyers the option of e-signing their loan documents, which offers the convenience of focusing the buyer on the signature line. That makes it even more important for the buyer to read all of the details and make sure they reflect the deal they agreed to.
Some lenders compensate dealers by allowing them to mark up the interest rate offered to borrowers; others compensate with a flat fee, either a set dollar amount or a percentage of the amount financed.
In dealer-speak, these fees are called “flats.”
In the F&I world, flipping means convincing a customer to switch from the loan they’ve pre-arranged to using the dealer’s financing.
Because dealerships make more of their money from loan markups and ancillary product sales than they do from selling cars, they have a strong incentive to convince borrowers to use their preferred loans. Of course, at Outside Financial, we think that most borrowers are better off saying no to the flip.
The four-square or worksheet is a tool that dealers use to convince buyers to accept their offer.
The dealer will show you four boxes on a page:
(1) your trade-in value,
(2) the purchase price of your new car,
(3) your down payment, and (4) your monthly payment.
Typically, none of these figures will look good to you when the dealer first shows them, but the dealer tries to get you to focus your attention on (3) and (4). By letting you think you’re getting a “good deal” on those, the dealer gets you to agree to a lower trade-in price and a higher purchase price.
And often the wiggle room you get on the monthly payment comes from extending out the term.
There are two types of car dealerships: franchise and independent. Franchise dealerships have contracts with manufacturers to sell their new vehicles.
(Franchise dealerships may also sell used vehicles, including those that were traded in by other customers). Independent dealerships don’t have contracts with any particular manufacturers, and under most states’ laws, they aren’t allowed to sell new cars. How can you tell the difference? Franchise dealerships will have a manufacturer’s name in their own, like Toyota of Bedford or Liberty Ford. Independent doesn’t necessarily mean small, though; big used car sellers like CarMax are considered independent dealerships.
GAP stands for Guaranteed Asset Protection. It covers the difference between the value of your car and what you owe on your loan if your car is totaled or stolen. GAP policies are one of the ancillary products often sold by dealerships in the F&I office (usually at highly inflated prices). At Outside Financial, we think GAP policies can be valuable, if bought at the right price. Check out our GAP page to learn more.
When is a late payment not late? When it’s made during the grace period. Lenders will often give borrowers a few extra days after a due date to make the required payment without charging late fees. Be sure to check your contract before assuming you have time to make your payments, however, because each one may have a different length of time they allow (or they may not offer a grace period at all).
Gross monthly income
Gross income is how much you make before taking out taxes or other deductions. If you earn a regular salary, your gross monthly income is just your annual salary divided by 12.
If you take out taxes and deductions from gross income, you’re left with your net income (what you actually have to spend on car loans, cool car accessories, and anything else in your budget).
An incentive is a sweetener or reward for doing something, like a sticker on your kid’s chart for brushing their teeth. In the auto finance world, an incentive is a bonus offered by a manufacturer for buying (or leasing) a certain vehicle.
If a model isn’t selling as well as the manufacturer hoped, it might offer cash rebates, low interest or subvented financing, or special lease deals to try to boost sales.
Incentive programs can change quickly, and they can also be very tailored – that is, the incentive may work for one trim level but not for another of the same year, make, model, or they can be used in one city but not a neighboring one. Some incentives are even tied to specific VINs.
Some incentives, like rebates or financing deals, are offered directly to consumers, while others are offered by the manufacturer to the dealer, and it’s up to the dealer how much (if at all) to share with the buyer.
There are two types of auto financing: direct and indirect. A direct loan is one that the borrower arranges with a lender directly (that’s what you get through Outside Financial).
Indirect financing is arranged by the dealership. Legally, an indirect “loan” isn’t really a loan; when a car buyer obtains financing facilitated by a dealership, the buyer and dealer sign a Retail Installment Sales Contract rather than a loan agreement.
The dealer then typically sells or assigns that contract to a bank, credit union, or other financial institution. Usually, the dealer knows in advance which financial institution will buy the contract and sets the contract rate accordingly. The borrower then pays off the financial institution the same as for a direct loan.
Interest is the amount you pay to borrow money. Most car loans are simple interest loans, meaning you only pay interest on the principal balance. (By contrast, for a compound interest loan, you would need to pay interest on the interest).
Unlike the APR, the interest rate for a loan doesn’t include other costs that lenders impose, like prepaid finances charges. That’s why the APR is higher, and it’s a better way to compare between loans.
A lease is a contractual agreement between a lessor (the person who owns the property) and a lessee (the person who gets to use it during the term of the lease).
Usually, car leases allow the lessee to drive the car for a certain number of miles (under 12,000 per year is standard) for a certain number of years (say, three years). The lessee pays a fixed monthly payment for the privilege of driving the vehicle, and when the lease ends, the lessee returns the vehicle to the lessor.
Lease rates aren’t just based on what the car is worth today because the lessee doesn’t buy the whole car. Instead, the lessee pays only for the value of the vehicle for the term of the lease (keep in mind that the first few years of a car’s life are when it’s worth the most, and most leases are for new vehicles). Lenders calculate lease payments based on the vehicle’s residual value, or what they estimate the car will be worth when the lease is over.
Let’s say you leased a car, and you fell in love with it. Your three-year lease term is up, but you don’t want to part with your baby. Or you really blew it on the number of miles you thought you would drive, and you’re facing a steep overage penalty. Either way, a lease buyout loan could help you to pay off the rest of your lease so that you can buy your car. The amount you need to borrow will be based on the residual value you agreed to when you signed your lease contract, plus taxes and fees set by your leasing company.
A lemon is a car that has substantial manufacturing defects that can’t be fixed. Most states have laws to help buyers who inadvertently bought lemons. Usually those laws are geared toward new car sales, but some also include used car buyers. Check out the helpful resources at Lemon Law America for more info.
A lien is a conditional legal right to a piece of property. A creditor takes a lien in a borrower’s asset so that if the borrower doesn’t pay back the money owed, the creditor can repossess the property to repay the debt instead.
Bonus legalese: the creditor’s right is conditional because the creditor can only take the asset under certain conditions, like if the borrower stops paying.
That “conditional right” is called a security interest. By taking out a car loan, you grant the lender a lien in your vehicle – that means the lender will have the right to repossess your car if you stop making your loan payments.
Loan-to-Value ratio (LTV)
LTV is one of the ratios that lenders use (along with DTI and PTI) to determine how much to lend and at what rate.
LTV compares how much your loan is for with the value of what you’re buying. It’s calculated by dividing the loan balance by the value of the asset.
For cars, it’s common for lenders to allow LTVs of up to 120%, which means that they’ll lend more money than the car is worth to allow borrowers to pay for ancillary products with the loan.
A car’s make refers to the brand of the vehicle – like Ford, Honda, or Toyota.
The maturity date for a loan is an exciting one for the borrower and the lender: it’s the day that the final payment is due, and the borrower owns the vehicle free and clear.
Mileage means the total number of miles that a vehicle has driven, usually shown on the odometer. Lenders need an accurate assessment of mileage in order to calculate the value of a vehicle.
A car’s model refers to the name of a manufacturer’s particular product. For example, the F-150 and the Mustang are models (the “make” for both is Ford).
One of the more confusing car loan terms you’ll hear at the dealership, the money factor, or lease factor, is a measure of the cost of borrowing under a car lease.
Although it sounds confusing, the money factor is just the APR divided by 2,400. So if you want to convert the money factor of .0015 you’re quoted into an APR you can compare to other loan offers, just multiply by 2,400 (3.6%, in case you don’t feel like doing the math).
One quick watch-out: some dealers will refer to the money factor as if it’s multiplied by 1000 to make it easier to say (so .0015 becomes 1.5), but you still have to do the math to figure out the APR. Another quick watch-out: there is no legal requirement for dealers to disclose the money factor in a leasing contract, so make sure you ask.
The Monroney or window sticker is named after Sen. Almer Stillwell "Mike" Monroney of Oklahoma. Sen. Monroney sponsored the Automobile Information Disclosure Act of 1958, which requires dealers to label all new cars with details about the year, make, model, and detailed pricing information, including the MSRP, delivery fees, and charges for any options or add-ons.
(The New York Times published an article to honor the 50th anniversary the history of Sen. Monroney and the Act; check it out here).
The Manufacturer’s Suggested Retail Price, aka the sticker price, retail price, or list price, is exactly what it sounds like: the manufacturer’s suggestion for what the dealer should charge. Dealers are free to price the vehicle above or below the MSRP, though, depending on what they think buyers will be willing to pay. The MSRP is equal to the base price plus any options (like a roof rack or sport package) and dealer fees.
Equity means the value of an asset (like your car), minus any debts or liabilities (like your car loan).
If you have negative equity in your vehicle (sometimes known as being upside-down or underwater), it means you owe more on your loan than your car is worth.
Lenders worry about negative equity because if they have to repossess a vehicle, they won’t be able to sell the vehicle to make up the amount that they’ve loaned out. If you have negative equity in your vehicle, consider refinancing and adding GAP insurance to protect yourself.
OEM stands for Original Equipment Manufacturer. In the auto world, it typically refers to companies that manufacture vehicles, like Ford, Honda, or Toyota. In most U.S. states, OEMs are required to sell their vehicles through dealerships, although the dealerships are actually separate businesses from the OEMs.
A car that’s “off-lease” is one that was returned to the dealership after the previous lease term ended. Some off-lease vehicles receive a special CPO certification (and a price boost to match), although not all will meet the manufacturer’s standards.
In general, off-lease vehicles can be a good bargain, because most leases have maximum mileage requirements and penalize lessees for excess wear and tear.
The outstanding balance on a loan is how much the borrower still has to pay.
Payment or price packing is a type of dealer fraud. The dealer presents the customer with an inflated monthly payment for the vehicle. If the customer agrees, the dealer then offers “free” ancillary products to make up the difference.
Because most customers focus on the monthly payment and not the overall price of the vehicle, it can be easy for unscrupulous dealers to cheat customers by fudging the math.
Payment packing is illegal. The best way to avoid being scammed (other than securing your loan from Outside the dealership) is to do the math yourself.
If the price of the car you agreed on divided by the number of months you’ll be paying it off doesn’t equal the monthly payment the dealer is showing you, there’s a problem.
Payment-to-Income ratio (PTI)
PTI is one of the ratios that lenders use (along with DTI and LTV) to determine how much to lend and at what rate.
It’s calculated by dividing your anticipated monthly payment by your gross monthly income. So, for example, if you expect to pay $400 each month on your car loan, and your gross monthly income is $5,000, your PTI is .08 or 8% (5,000 ÷ 400 = .08).
Each auto lender sets their requirements for PTI differently, but in general, lenders look for a PTI lower than 15%.
That means your car payments aren’t going to take up more than 15% of your gross monthly income.
Power of Attorney
No lawyers are harmed (or even necessarily consulted) in creating a power of attorney. A Power of Attorney (or POA) is a document that grants permission to another person to act on your behalf, usually for a specific reason or under a certain condition.
For example, if you refinance your auto loan, you will likely need to sign a POA to allow your new lender to process the title paperwork on your behalf. (Otherwise, you’ll have to go down to the DMV yourself).
Power booking is a type of dealer fraud in which a dealer lies to a bank or credit unionthat a vehicle has more options or features (like a sunroof or power steering) than it really does.
The dealer’s goal is to get the financial institution to lend more money to the customer, often because the dealer is overcharging the customer. Not only is power booking illegal, but it can be really bad for the car buyer, who is now stuck owing way more money on the loan than the car is worth.
A loan with precomputed interest (also known as “add-on interest”) is one in which the interest is calculated at the start of the loan, not as payments are made. The total loan will include the amount financed (what you borrow to buy your vehicle), the precomputed interest, and any finance charges.
The monthly payment on the loan will be the total starting balance divided by the loan term (the number of months over which you’re paying off the loan).
Unlike with a simple interest loan, precomputed loans don’t amortize, which means that the monthly payment on a precomputed interest loan goes toward the same mix of interest and principal. If you pay off a loan with precomputed interest early, you should receive a refund for the unearned interest.
That’s because the monthly payments were calculated assuming the interest would grow over the loan term. If you pay it off early, that interest hasn’t had a chance to grow.
Prepaid financing charge
A prepaid financing charge is a fee the lender imposes upfront (at the time you take out the loan). For auto loans, these charges typically include the cost to pull your credit report, other processing fees, and the interest that accrues from the day you take out the loan until your first payment.
Just because prepaid financing charges are “due” upfront doesn’t mean you actually have to pay them in cash – they are usually included in your loan.
Lenders tend to like long loan terms, because it means they have a guaranteed source of interest income for the length of the loan. If a borrower tries to pay back a loan early, the lender will make less income. To make up the difference, some lenders impose penalties for paying off loans before they become due. Not all lenders charge prepayment penalties; if a lender does, it should be explicitly spelled out in the loan contract.
When you submit your information to Outside Financial, we pre-qualify you for a loan with one of our lender partners. What does that mean?
We do a soft inquiry of your credit to learn more about your credit history so we can match you with the right lender offers. Because you provided the information to us and requested that we match you, you’re considered pre-qualified for a loan.
If instead we bought a list of people with certain credit history from one of the credit bureaus and sent a marketing email or letter to each one, each of those potential borrowers would be considered “pre-approved.” (And both are different than being approved, which only happens after the lender has had a chance to do a hard inquiry on your credit).
The principal balance for a loan is the amount of the debt that still has to be paid off, not including interest.
(If you add in interest, you get the payoff balance – the amount you actually have to pay to pay off the loan in full). At the beginning of the loan, before you make any payments, the principal includes the amount financed plus finance charges.
Private party sale
If you’re scanning Craigslist ads for used vehicles or looking at the “for sale” sign on a car parked on your street, you’re interested in a private party sale – that is, one that takes place outside a dealership. Many lenders are nervous about lending money for private party sales because they think there is a greater risk of fraud without a dealer.
Proof of income
Proof of income, or POI for short, is one of several documents (or “stips“) that lenders might require before agreeing to loan a borrower money.
Because a borrower’s income is so important in calculating whether and how much money to lend, lenders often need to see proof that the borrower makes as much as they claim.
Typically, borrowers can prove their income using W2s, pay stubs, or last year’s tax returns.
Proof of residence
Proof of residence, or POR for short, is one of several documents (or “stips“) that lenders might require before agreeing to loan a borrower money. Knowing where a borrower lives is important to lenders for a few reasons; for starters, they need to know where to send important statements, including monthly bills. If the borrower doesn’t repay the loan as promised, lenders also need to know where the car is parked to repossess it. Borrowers can usually prove their residency with a utility or phone bill.
A rebate is an incentive from the manufacturer to the buyer for purchasing a certain vehicle.
Manufacturers often use them to encourage the sale of certain models that aren’t selling as well.
Rebates tend to change quickly, and eligibility may depend on geographic location and other factors, so it pays to read the fine print if you see an advertisement featuring a manufacturer’s rebate for a vehicle you’re interested in
A recourse loan or recourse debt is one where the borrower is personally responsible for the debt even after any collateral securing the loan has been repossessed by the lender.
For example, imagine that a borrower defaults on a car loan, and the lender repossesses the car. The lender sells the car for $5,000, but the borrower’s outstanding balance was $8,000. Under a recourse loan, the lender could sue the borrower for the remaining $3,000.
Most car loans are recourse loans.
Some lenders will ask borrowers for the names and contact info of 2-3 people who know them, like co-workers, friends, or relatives.
The lender’s goal is to be able to find the borrower if something goes wrong (that is, if the borrower doesn’t repay the loan as promised).
Most lenders won’t contact the references unless that happens, but they might, especially if they want to confirm that the references are real and actually know the borrower.
Refinancing means paying off an existing loan with a new one. The new lender pays off the full balance of the old loan, and usually handles the process of changing the name on the title with the DMV.
The borrower starts repaying the new loan under the new terms. At Outside Financial, we help borrowers find lenders to refinance their auto loans.
You can learn more about refinancing and find out if it makes sense for you here.
Every state requires anyone who owns (or leases) a car to register with the state’s Department of Motor Vehicles (and pay the required taxes and fees, of course).
Once you register the vehicle, you’ll receive license plates, a registration certificate, and often a decal to put on the license plate or window.
Residual means remainder, or what’s left. In car financing, residuals are the estimate of what a car will be worth when a lease ends.
The residual value for each vehicle is different – it depends on how quickly it is expected to depreciate.
The better a car holds its value, the higher the residual value, and the lower the lease payments will be.
Residual values typically aren’t negotiable, but if you want to lease, it’s smart to shop around for vehicles that have higher residual values.
Retail Installment Sales Contract
When borrowers obtain indirect financing through the dealership, they’re not actually taking out a loan.
They sign a Retail Installment Sales Contract rather than a loan agreement, although both documents spell out the same elements like term, APR, interest rate, and repayment terms.
The dealer then typically sells or assigns that contract to a bank, credit union, or other financial institution.
Riding all the rides
“Riding all the rides” is dealer slang for customers who purchase every ancillary product that the dealership has to offer, from GAP to VIN etching.
(For our take on why it’s a bad idea to “ride all the rides,” check out Four to Get, Five to Forget).
Rustproofing is one of the ancillary products offered by dealerships in the F&I office.
Usually, the dealership will charge extra to spray a substance (like oil or tar) on the outside of the vehicle to prevent corrosion.
Because today’s cars are much less susceptible to rust than older models, paying for extra rustproofing is almost always a waste of money. (For our take on which products are valuable and which ones are a waste, check out Four to Get, Five to Forget).
A loan that’s secured is one that is backed by some kind of collateral, like a car or a house.
These types of loans are less risky than unsecured loans because the lender can repossess and sell the collateral if the borrower defaults (or doesn’t repay the loan as agreed).
Simple interest loan
In a simple interest loan, the borrower makes the same payment each month, with part of the payment paying off the principal balance and part paying off interest.
The interest doesn’t compound – that means the borrower doesn’t owe interest on interest.
By contrast, in a precomputed or add-on interest loan, all of the interest due over the term of the loan is calculated when the loan is made and added to the principal. The borrower’s monthly payments go toward that total balance and are not split up between principal and interest.
Most car loans are simple interest loans, but precomputed interest loans are common among lenders specializing in subprime credit.
A soft credit pull or inquiry is a request for information about your credit history from a credit bureau that doesn’t affect your credit score.
When you apply to be pre-qualified for an auto loan through Outside Financial, we do a soft pull of your credit on Experian.
That helps us to determine whether we can match you with one of the lenders on our platform. If you request your own credit report, that would also be considered a soft pull.
It’s a nightmare scenario: you drive home with your new car, hang up your lucky dice, and congratulate yourself on getting a good deal.
Then a few days later, you receive a call from the dealership informing you that your financing fell through and you need to return the vehicle or sign up for a different loan, at a much higher interest rate and with a larger down payment. Most of the time, you’re being scammed – occasionally, a deal will fall through, but dealers are typically too smart to let you take a vehicle off the lot if they’re not sure they’ll be paid.
Spot delivery is also known as a “yo yo sale” because the buyer is pulled back to the dealership.
Stipulations, or “stips,” are anything that lenders require as part of the underwriting process as a condition for lending to a borrower.
Common stips include a driver’s license, proof of income, and proof of residence.
A straw purchase is a bait-and-switch scheme in which a borrower with good credit borrows money to buy a car for another person with less-than-great credit.
It’s a type of fraud, and it’s usually illegal. Retail Sales Installment Contracts and loan agreements require the primary borrower to be the primary driver of the vehicle, and lying on any legal agreement is a bad idea.
Straw purchases also don’t help the credit-challenged buyer to build a good credit history.
Structuring a finance deal is dealer-speak for putting the financing package together, including figuring out the amount of down payment the buyer is able to make, the buy rate from the lender, and the contract rate to charge the borrower.
To subvent is to support or help someone else financially. In auto finance, vehicle manufacturers are the ones providing the financial support, usually in the form of lower interest rates.
Manufacturers often subsidize financing to encourage consumers to buy their vehicles. They’re the ones behind “0%” financing deals you may see advertised.
A loan term is how long the loan is supposed to last until it must be repaid. Most loan terms are expressed in number of months, so a loan that will be repaid over five years is said to have a 60 month term.
In making decisions about whether to lend to a prospective borrower, how much, and at what rates, lenders typically focus on three characteristics:
Credit score and history of the borrower: measures of how much of a risk it would be to lend that borrower money
Collateral: the value of the car the borrower wants to buy or that would secure the loan to be refinanced, often measured by the Loan to Value ratio
Capacity to pay: how much income or assets the borrower has available to pay off the loan, usually calculated using Debt to Income and Payment to Income ratios
Each lender weighs these factors slightly differently in making underwriting decisions, which helps to explain why some borrowers may get vastly different loan offers from different lenders.
Tire & Wheel
Tire & Wheel products are one of the ancillary products typically offered in the F&I office of a dealership.
T&W, as it’s known, pays the replacement or repair costs for tires and wheels due to damage from road hazards.
It includes the cost of tires, mounting, balancing and valve stems, but doesn’t cover normal wear and tear. At Outside Financial, we think T&W can be valuable, if bought at the right price. (For our take on which products are valuable and which ones are a waste, check out Four to Get, Five to Forget).
A vehicle’s title is like the deed for a house. It is a legal document that shows who owns the vehicle.
In some states, the title will show the owner of the car, regardless of whether there’s a loan outstanding. In other states, the title will show the name of the lender (“lienholder” in legalese), which will need to be updated if the loan changes – for example, if the borrower pays off the loan or refinances to a different loan.
Any car loan uses your car as collateral – that is, your car secures the loan so that if you don’t pay back the lender as promised, the lender can repossess the vehicle. For a regular car loan, the money you borrow goes directly to the seller to buy the vehicle.
A car title loan, sometimes known as a pink slip loan, title pledge, or title pawn, also uses your car as collateral, but it’s typically for a much shorter term (either 30 days or 3-6 months) and its purpose is different.
Usually, borrowers use car title loans to get cash quickly. The problem is that these loans are very expensive. APRs can be 2-300%, and most lenders charge a lot in fees.
That’s why the FTC recommends against getting a title loan if you have other options. Although everyone’s situation is different, refinancing your existing car loan may be a better choice if you need budgetary relief.
A car dealership assigns two values to any vehicle you trade in: the Actual Cash Value (ACV for short) and the Trade-In Allowance.
The dealership probably won’t tell you the ACV, but it’s what they’ll use to actually put a value on the vehicle. They will show you the Trade-In Allowance, which is the amount they’ll put on the buyer’s order to reduce what you owe for your new vehicle.
If the ACV is higher than the Trade-in Allowance, the dealership makes a profit.
But if you insist on a higher value for your trade-in, and refuse to buy a car unless you get it, the dealership may be able to offer an “over allowance,” or a Trade-in Allowance that’s higher than the ACV. They will lose money on buying your trade-in, but they’ll try to make up in other ways, like increasing the car purchase price, marking up your financing, or selling you ancillary products.
As if car buying wasn’t complicated enough, most vehicles come in multiple trim levels. The trim level refers to the set of features that the vehicle was manufactured with.
Take the Ford F-150. Just knowing the make (Ford) and the model (F-150) doesn’t give you enough information to put a value on the vehicle.
There’s a wide price difference depending on whether you select the F-150 Raptor, the Lariat, the King Ranch, the Platinum, the Limited, the XL, or the XLT.
Then you have to know if you’ve selected a Regular, SuperCab, or SuperCrew version. And even among Regular Cabs, you can opt for four-wheel drive or rear wheel drive, the FX4 Off-Road package, the Max Trailer Tow Package, and a number of other bells and whistles. For a 2018 F-150, the base model XL goes for $27,705, while a fully loaded Limited costs more than double that: $64,275. If you aren’t sure of the trim level, the best place to look is the sales invoice or window sticker of the vehicle.
Sometimes, the trim will also be in the owner’s manual or on a decal or lettering on the vehicle itself. Letters like 4X4 or 4wd mean four-wheel drive; 4X2 or 2wd can either refer to front or rear wheel drive. AWD stands for all-wheel drive.
Truth in Lending Act
The Truth in Lending Act (TILA) is a federal law enacted in 1968 to protect consumers. The Act has many provisions, including one requiring lenders to disclose certain information about a loan to prospective borrowers, including the loan’s APR , any finance charges , and the total amount financed .
It’s important to review TILA disclosures carefully before agreeing to any loan.
Underwriting is the process lenders go through in deciding whether to lend money to borrowers, and if so, how much and at what rate.
For car loans, lenders typically focus on the “3 Cs”: credit, collateral, and capacity.
Most lenders still take a manual approach to underwriting, which means that a real person is reviewing every loan application before making a decision.
Vehicle Identification Number (VIN)
A vehicle identification number (VIN) is like a Social Security Number for your vehicle. Every vehicle has a unique combination of 17 characters (numbers and letters) that identify its year, make, model, and other key features.
No two cars built within 30 years of each other can have the same VIN.
The VIN numbers might appear random, but they actually tell you a lot about the vehicle. For example, the first digit identifies the country where the vehicle was manufactured.
Cars made in the U.S. start with 1, 4, or 5, depending on region. The second digit identifies the manufacturer under a code assigned by the Society for Automotive Engineers.
VIN etching is an ancillary product designed to deter thieves by carving or etching with acid the VIN onto the vehicle’s windshield or window.
Thieves sometimes try to resell car parts, including windows, and having a VIN engraved on the window makes them less valuable.
Thieves will also try to erase the VIN from other locations, and it’s much harder to do that when the VIN is etched rather than on an easily removable part.
At Outside Financial, we recommend against purchasing etching from the dealership. If you want to etch the VIN on your windshield, Amazon offers a kit for $20.
One trick that some shady dealerships use is etching the VIN in advance. If your dealership does that, either find a new dealer or refuse to pay.
Considering that VIN etching costs the dealer less than $25, no buyer should ever be on the hook for the hundreds of dollars that many dealerships charge.
Vehicle Service Contracts (VSCs)
VSCs, sometimes mistakenly referred to as extended warranties, are like health insurance for your vehicle.
You pay a small amount each month, and the VSC company will cover all or most of the cost of necessary repairs.
At Outside Financial, we think VSCs can be valuable, if they’re bought at the right price.
You can find out a lot more about VSCs, what they cover, and whether they’d be a good investment for you, by visiting our Vehicle Service Contract page
A warranty is a promise by the manufacturer to stand behind the product if something goes wrong. In the car finance world, some warranties are explicit, like when a manufacturer offers to repair or replace an item if it turns out to be defective, usually for a set period of time or for certain specified issues. Some warranties are “implied,” meaning that the manufacturer doesn’t say anything but is still on the hook. All states have laws in place that govern implied warranties. Only the manufacturer of a product can offer a warranty. That’s why Vehicle Service Contracts offered by anyone other than the vehicle’s manufacturer are not actually “extended warranties.” VSCs may cover some of the same repairs as the manufacturer’s original warranty, but they usually only kick in after that original warranty has expired.
This car term (also known as a talk track) is a car dealer’s script for “overcoming objections,” to use another favorite dealership term.
Savvy dealers know what most car shoppers worry about, and they’re skilled at addressing those concerns (or at least appearing to).
Your best bet if you’re in the market for a car is to arm yourself with your own word track so you know how to respond to common dealer “objections”; our tools make it really easy.