Car finance explained

Car finance can allow you to spread the cost of your new car over a period of time. This makes a lot of sense for a lot of people, but there are a number of different types, and understanding the differences between them can be complicated. And, once the financial acronyms start flowing, it’s very easy to get lost. That’s where Auto Trader’s Car Finance Glossary can assist.
We’ve put together a list of these complicated terms that a salesperson might start throwing around when talking about ways to pay for your car, along with explanations for each, so that you’ll be clued-up and super-prepared when talking about your options. First off, here’s a brief explanation of the different types of car finance…

Hire Purchase or HP

A way of buying where you pay a deposit up front, and then pay off the rest of the balance – plus the interest - in equal monthly instalments. At the end of the agreement, you will own the car. By paying a bigger deposit, you can make your monthly payments smaller. Even so, the repayments are high compared with other types of finance, but they don’t change until the end of the agreement. So, provided you keep them up, you will know exactly how much you are paying, and for how long, and the car is yours at the end of the agreement.
More detail…

Personal Contract Purchase or PCP

You pay an initial deposit, followed by lower monthly instalments for the remainder of the term to pay of a proportion of the loan amount. Then at the end of the term, you have the option to pay a large final payment to clear the remaining balance and own the car outright. If that’s not for you, you have other options, too. Provided you haven’t exceeded your pre-agreed mileage limit and the car hasn’t suffered damage over and above normal wear and tear, you can hand the car back and walk away, or you can exchange it for another car from the same dealer (new finance is subject to status), using any equity you’ve built up in your current car towards your down-payment.
The amounts of deposit, monthly payments, final payment and length of agreement can be adjusted to suit you, but monthly payments are typically lower than on Hire Purchase, so you can afford a swankier car for your money, or just pay a bit less. You’ll also have to pay an extra charge if you’ve gone over the agreed mileage limit, or if there’s damage on the car over and above what the lender would consider to be ‘wear and tear'. Learn more about PCP.

Personal Contract Hire or PCH

Technically, this is a method of leasing (hiring on a long-term basis) a car rather than getting finance to buy it, but it’s still a way of getting into a brand new car for affordable monthly payments. Typically, you pay a deposit and monthly instalments, both of which tend to be lower than with HP or PCP, but you never own the car. At the end of the agreement, you either hand it back (provided you haven’t exceeded your pre-agreed mileage limit) or sign up to another agreement.
More detail…

And now, here are some of the terms you might hear…

APR or Annual Percentage Rate

The amount of interest you’ll pay yearly on the money you’ve borrowed, including the various fees that apply, so that you can accurately determine and compare the overall annual cost of your agreement. APR should not be confused with the ‘Flat Rate’, which is the rate of interest not including fees. When comparing finance deals, always make sure you’re comparing like-for-like.
More detail…

Balloon payment

The large final payment at the end of a PCP agreement that means you own the car outright. It’s essentially a portion of the loan amount that’s deferred until the end of the loan, making your monthly payments lower. You can choose not to pay the balloon payment, but obviously, that’ll mean you won’t own the car. Usually, the balloon payment is the same amount as your car’s Minimum Guaranteed Future Value or MGFV.

Credit agreement

The document that details the terms of the package you enter into with the finance company.

Credit history/rating/credit/record

Information on your previous borrowing record that the lender will check in advance to decide if you’re a reliable person to lend to.

Depreciation

The value that your car loses over time due to things such as age, mileage and wear and tear.

Equity/negative equity

Equity is when the market value of the car is more than what you still owe on it, and you can either pocket the difference or use it towards a deposit on another car.
Negative equity is when you owe more on the car than the car is worth, and unfortunately, you’ll be liable for the difference. You can sometimes settle the amount yourself or you may be able to carry the amount across to a new deal for another car.

Financial Conduct Authority or FCA

A body that regulates the UK’s financial services industry. It aims to protect consumers and monitor the conduct of lenders to help ensure stability.

Fixed rate

Means that your monthly payments won’t be affected by changes in the interest rate (e.g. Bank of England Base Rate), and will always remain the same.

Flat rate

The amount of monthly interest you’ll pay, not including fees. That’s what makes it different from APR, as that does include fees.
More detail…

Guaranteed Asset Protection insurance or GAP insurance

If your car is stolen or written off during your finance agreement, you’ll still be legally liable to pay off any outstanding finance on it. Surely, your car insurance will take care of that, right? Maybe not. Regular insurance will usually only pay out the market value of the car at the time of the incident, factoring in depreciation, regardless of what you paid for it or how much you still owe, and that means there can sometimes be a shortfall. GAP insurance is designed to protect you against that shortfall by making up the difference between your insurance payout and the balance owed.
More detail…

Mileage allowance/Excess mileage

To protect the value of the car at the end of the finance agreement, you’ll be asked at the beginning to estimate how many miles you will drive. The size of your deposit, monthly payments and (if applicable) final payment will then be calculated based on this. If you’ve exceeded this limit at the end of the agreement, you may have to pay extra on a pence-per-mile basis.

Minimum Guaranteed Future Value or MGFV

The absolute lowest amount that your car will be worth at the end of your agreement. It’s important because this value, calculated by the lender, will also be used to calculate the amounts of your deposit, monthly payments and (if applicable) balloon payment.

Part-exchange

When you trade-in your existing car, using its value as part of the payment for a new one.

Residual/resale value

The value of your car at the time you part ways with it.

Term

The period of repayment, which you’ll find in your agreement as the number of months over which your payments are spread.

Total amount payable

The total amount you’ll have paid come the end of your finance agreement. This figure includes your car’s on-the-road price, plus any interest and charges applicable.