When arranging finance for your next car, it’s likely that you’ll come across some phrases you’ve not heard before. It’s vital you understand all the terms and conditions before signing on the dotted line, so use this jargon buster to find out what they mean. If you’re unsure about any aspect of your agreement or come across a term we’ve not mentioned, you can use our ‘Ask an Expert’ feature.

Below are commonly used car finance terms, with explanations.

Administration fee

This is a charge for setting up the finance and issuing the relevant documents. The cost will be included in the total amount payable and taken into account when the Annual Percentage Rate (APR) is calculated. It can sometimes also be referred to as a Documentation Fee.

Agreement term

The length of time over which you agree to repay the finance – also referred to as the Length of the Agreement.

Annual Percentage Rate (APR)

The APR shows the annual cost of a finance agreement over and above the amount you have borrowed. The APR will include interest rate charges and any other fees included in the agreement, such as administrative fees. By law, the APR must be shown on relevant documentation presented to customers in showrooms. You can use the APR to compare the cost of different finance products.

Annual mileage

In some finance agreements, such as Personal Contract Purchase and Lease Purchase, you will be asked to estimate your annual mileage at the beginning of the contract. This estimate helps the lender calculate the market value of the car at the end of the agreement (also referred to as the Guaranteed Minimum Future Value).  It’s important to be realistic because excess mileage is chargeable. This will be explained to you by your car dealer.

Bad credit history

This refers to people who may have experienced repayment issues in the past and therefore do not have a great credit rating. You can check your credit rating with reference agencies including CallCredit, Experian, and Equifax. If you have adverse credit there are specialist lenders who can still help you, and some are listed in our member directory.

Balance financed

This is the amount you need to borrow – usually the selling price of the car, less any deposit or part exchange allowance.

Balloon payment

A balloon payment is the lump sum (also known as a Guaranteed Minimum Future Value) deferred to the end of a finance agreement in Personal Contract Purchases, Lease Purchases or similar agreements. It completes the finance agreement and allows you to take ownership of the car. You may be obliged to pay a balloon payment under some agreements, while it is optional under others – so be sure to check which type of agreement best serves your needs.

Cash back

This is an amount refunded to the customer (typically from a car’s part-exchange valuation) which is not required for a deposit. It can be an incentive used to attract new car buyers. The relevant schemes will vary between manufacturers.

Conditional Sale

Conditional Sale is a type of finance agreement where the sale of the vehicle is conditional on the customer completing the terms of the agreement – for example, making all of the repayments and paying other charges. These contracts are broadly similar to Hire Purchase agreements, except that the customer will automatically own the car at the end of the agreement rather than paying a fee for ownership, as in a Hire Purchase agreement.

Credit agreement

A credit agreement is a legally-binding contract between the customer and the finance company. It must include details of the loan amount, the term, rates of interest, other charges and your rights and responsibilities for the duration of the agreement. You will receive a copy of the agreement you have entered into.

Credit rating

A part of the scoring system used by finance companies to help them decide how to price the risk of doing business with you, and arrive at a suitable interest rate.

Deposit contribution

A new car dealer can sometimes make a contribution to the minimum deposit payment required under a finance agreement as part of a promotional or marketing campaign. This will help reduce the cost of your finance, but will be subject to your being approved for, and taking out, the finance agreement where the deposit contribution applies.

Depreciation

Depreciation refers to the extent and speed of the loss of value, and some cars will depreciate much quicker than others.

Documentation fee

This is a charge for setting up the finance agreement and issuing the documents. The cost will be included in the total amount payable and taken into account when calculating the Annual Percentage Rate (APR). See also Administration Fee.

Early settlement

This is when a customer pays off a finance agreement before the agreed term is completed. By doing so the customer may save on the interest that would have been charged for the remainder of the agreement.

Equity

Equity refers to the difference between the agreed market value of the car and the loan balance left to pay. If the market value of the car is higher than the outstanding finance, then the customer has equity in the car. If it is lower, the term ‘negative equity’ is often used.

Final payment

This is the last repayment to be made under a finance agreement, and can include a voluntary option to purchase fee (under a hire purchase agreement) or a balloon payment (typically under a Personal Contract Purchase or Lease Purchase agreement).

Fixed rate

This means the same interest rate is charged for the duration of the agreement.

Flat rate

This is the base interest rate charged on the finance. Dealers will sometimes quote a monthly or annual flat rate, but you should always ask for the Annual Percentage Rate (APR), which more accurately describes the true cost of the finance. The flat interest rate does not include other charges like any administration fees.

GAP insurance (Guaranteed Asset Protection)

If your car is involved in an accident, your insurer will only pay for its current market value.  GAP insurance can help cover the difference between the market value of the car and the amount of outstanding finance  under your credit agreement (Finance GAP), or the original purchase price of the car (Return to Invoice GAP). There are various types of GAP insurance on the market, so shop around and choose a product to suit your needs.

Gross income

This refers to your income before tax and National Insurance have been deducted. You may be asked for this information when completing a finance application.

Guaranteed Minimum Future Value

This is where a percentage of the total cost of the car is deferred until the end of the contract. The forecast value of the car is assessed by the finance company at the beginning of the agreement. This is known as the Guaranteed Minimum Future Value.

In agreements such as Personal Contract Purchase, it is important to be realistic with your estimates of how many miles you expect to cover each year as this will help determine the GMFV (as well as the length of the agreement). See also Balloon Payment.

Hire Purchase

Hire purchase (HP) is a popular car finance product. When taking out an HP agreement, you pay an initial deposit, then a fixed monthly repayment over a set number of months. Although you become the ‘registered keeper’ of the car, you are only hiring it and you don’t actually own it until you have made the final repayment (including any administration or option to purchase fee).

Insurance

Car insurance is a legal requirement in the UK for motorists, and it will normally be a condition of a finance agreement that your car has comprehensive cover at all times.

Interest rate

When you borrow money as part of a finance agreement, the price you are charged for doing so is called the interest rate. The level can sometimes be dependent on your credit history.

Joint application

In some circumstances, you may want to consider a joint application for car finance. This is where two or more people apply for finance one a single application. This could improve your chances of meeting a lender’s affordability calculations. Check with your local dealer to see if this option is available to you.

Lease Purchase

Lease Purchase is a form of Hire Purchase agreement under which a sum is deferred until the end of the contract. This is determined by the projected age of the car and the forecast mileage. Unlike with Personal Contract Purchase (PCP) agreements, the deferred amount (also referred to as a balloon payment) is not optional and must always be paid.

Monthly rentals

Monthly rentals are what you pay every month under certain agreements like leases. They are referred to as rentals – rather than repayments – because you generally do not have the option to own the car outright and will need to return it to the leasing company at the end of the agreement.

Net income

Your earnings after income tax and national insurance have been deducted.

Option to purchase fee

A voluntary payment at the end of some finance agreements (such as hire purchase) which, if paid, transfers ownership of the car from the finance company to the customer.

Part-exchange

Part-exchange involves trading in your existing car and using its value as part payment for your new car, perhaps to help fund a deposit under a finance agreement.

Personal Contract Purchase

Personal Contract Purchase (PCP) is a form of hire purchase agreement, which includes a voluntary “balloon” payment at the end. This final amount represents the future residual value of the car, based on the age of the vehicle at the end of the agreement and the forecast mileage.

Monthly repayments are generally lower under a PCP agreement than a comparable HP agreement because of this deferred amount. With this type of agreement, payment of the future value of the car is optional. it must be paid if you wish to own the car outright, but you could simply decide to hand the keys back and start another agreement for a different vehicle.

Quotation

A quotation provides an indication of the costs that would apply if you went ahead with a finance agreement. The information shown in the quotation is prescribed by law and must include any deposit required, the monthly repayments, any balloon payment, the Annual Percentage Rate (APR), other charges and the total amount payable. Asking for a quotation does not commit you to entering into an agreement at a later date, and will not leave a ‘footprint’ on your credit record.

Residual value

This is the value of your car at the end of the finance agreement. It may or may not be guaranteed by a finance company, depending on the terms of your contract. The residual value is determined by the resale appeal of the car, the mileage on the clock and the length of your finance agreement.

Secured loan

The majority of car finance agreements are secured against the vehicle. This means less risk all around as the car is recoverable in the event of payment difficulties, but the lender has greater flexibility in the terms and conditions that they can offer you.

Secondary rental

If you want to keep renting the car once a lease agreement comes to an end, you can usually arrange a second agreement for the same car – typically in the form of either an annual rental or monthly repayments. This is often called a secondary rental.

Term

This is the length of time over which you agree to repay the amount of finance you have borrowed.

Trade value

This is how much the car is worth if sold at auction or bought by a motor dealer. Most non-prime finance companies will only lend up to a maximum of a car’s trade value.

Unsecured loan

An unsecured loan is not secured against any asset, such as the car you have financed. This means the risks to the finance company may be higher so there may be less flexibility in the terms and conditions of the agreement.

Variable rate

This means that the interest rate can go up or down depending on the Bank of England’s interest rate during the term of your finance agreement. This type of finance agreement is more common in the mortgage market.

VIN

VIN is the abbreviation for Vehicle Identification Number. This is a unique number that every car has in order to track its identity and prevent fraud. A VIN cannot be changed, unlike a car’s number plate.

Warranty

Car manufacturers normally provide a warranty on new cars which will cover the cost of unexpected mechanical problems.  Warranties are also available for used cars, but do shop around.