Car Finance Explained

Car finance jargon explained

The number of motorists choosing to use a loan to buy a new car has soared over the past few years – partly as the result of the introduction of new types of finance.

But some of these deals can be particularly complicated – a fact that is not helped by the amount of jargon used to describe the various aspects of each kind of loan. Below we explain what some of the most common and confusing terms actually mean.

What is APR?

APR stands for annual percentage rate and it is an indication of how much interest you will pay on a loan on an annualised basis. The APR can include not just the interest rate on the loan but also a proportion of other charges, such as administration fees, that you might face over the course of the loan.

What are balloon payments?

With personal contract purchase (PCP) deals (see below), customers have the option to buy their car at the end of the deal by making a final lump-sum payment – this is known as a balloon payment. Balloon payments may also be a condition of some hire-purchase agreements.

What is equity?

Equity is the difference between the current market value of the car and what the borrower owes on it – provided the former figure is higher than the latter. At the end of a PCP deal, if the car is actually worth more than the guaranteed minimum future value (see below), this equity can be used as a deposit on a subsequent loan.

What is gap insurance?

This is insurance to pay the difference between the current market value of the car and what the borrower still owes on it. It is used for when a vehicle is stolen or written off: the insurer will only pay their policyholder the current market value of the car. But if this is less than the outstanding loan, the borrower will find themselves having to make up the difference – and this is what gap insurance is designed to do

What is Guaranteed Future Value (GFV)?

With PCP deals, each car has a guaranteed minimum future value (or guaranteed future value, GFV): this means that, at the end of the loan term, the lender expects the vehicle to be worth this much, and the borrower can take ownership of the car by simply paying this amount.

If the car has depreciated more than expected, however, and is worth less than the GFV, the borrower is not at risk: they can simply hand the vehicle back to the lender and walk away.

Hire purchase

This is a finance agreement where borrowers pay a deposit plus monthly payments in order to become legal owner of the car at the end of the loan term. In some cases, customers will be required to make an extra final payment – sometimes called a balloon payment (see above) – before taking ownership. Find out more.

What are mileage limit

The price of PCP and leasing deals is normally worked out based on how much the vehicle in question is going to be used – in agreement in advance with the borrower. Annual mileage limits are set accordingly, and borrowers who exceed these limits can be charged penalty fees.

What is personal contract hire?

Personal contract hire or PCH is another term for leasing – long-term rental of a car. This involves paying a monthly fee for the long-term rental of a vehicle – most commonly a brand-new model – over a pre-agreed period such as two or three years. Find out more.

Personal contract purchase (PCP)

PCP is one of the most popular forms of finance, in particular for new-car purchases. It involves making a deposit and monthly loan repayments, typically over a three-year period. At the end, the customer can buy the car by making a final balloon payment (see above), they can use any equity remaining in the car as part of a deposit on a new deal, or they can hand the car back and walk away.

What is a transfer fee?

At the end of a hire-purchase agreement, the customer may have to pay a transfer fee, usually in the region of of £100-£200, to take full ownership of their vehicle. This fee is payable on top of the monthly payments, and possibly also initial deposit, that the customer has already made.

For further information on car finance read our car finance guide.

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