A guide to car finance terminology

A guide to car finance terminology

Tuesday, 2 October 2012 12:24 PM

Car finance seems to have a language of its own

Car finance seems to have a language of its own

Affording a used car may be easier than you think, as there is a wide range of finance products available. However, it can be difficult to work out which of them is most suitable for you, as the industry uses so much jargon.

Some of the terminology used falls into the category 'legal speak', whereas much of it could easily be described as 'marketing talk'. Either way, it is hard to understand and makes it tough to compare deals.

We've tried to simplify some of the common terms below, so you should at least have a basic idea of what you are considering when you come to buy a used car with finance.


The APR – or annual percentage rate, to use its full name – is the real rate of interest you will be charged on the money you borrow. It includes fees as well as interest payments, so is the best way of working out how much you will actually have to pay.

Some lenders also express interest rates in other ways, but they are all required to calculate the APR using the same method and give you that figure. As a result, it is the best way to compare the cost of loans when trying to decide which is the best deal for you.

Credit rating

Also known as a credit score, this is used by lenders to assess your ability to repay any money borrowed and is usually the decisive factor in whether your loan application is accepted or rejected. Issues such as your employment status, salary and whether you are a homeowner are all taken into consideration, as is your previous borrowing record.

Typically, a good rating will mean finance companies are willing to lend you money at a competitive rate. However, if you have a track record of defaults and late payments, you will be regarded as a credit risk and either have to pay a higher rate of interest or have your loan application turned down.

If you are rejected for a loan and can't understand why, it is worth contacting one of the leading credit reference agencies for further information. You may find some of the details on your file is incorrect or out of date.

Personal loan

This is the form of finance many people are most familiar with. It works in a simple way, as you borrow a certain sum and repay the capital and interest in monthly instalments over a set period.

Personal loans from banks tend to be unsecured and come with a fixed interest rate. However, some lenders may ask you to put your house up as security before lending, which means your property is at risk if you fail to make the repayments. Occasionally loans are offered with variable rates, which could mean they prove more expensive than you had budgeted for if interest rates rise sharply.

Hire purchase (HP)

An HP agreement is a straightforward way to finance a used car purchase. You will be required to put down a deposit and then borrow the rest of the money you need at a fixed interest rate.

The cash is then repaid in monthly instalments over an agreed period of between 12 and 60 months. The car will be yours at the end of the contract, as long as you make all the repayments.

As the loan is secured against the car, you will not have to use your house or other assets as collateral. HP agreements also allow you to hand the vehicle back to the finance provider once you have made half the repayments, provided it is in a good condition.

Personal Contract Purchase (PCP)

This is perhaps the most difficult form of car finance to understand, but it will help you to keep your monthly payments down. A substantial portion of the loan is deferred until the end of the agreement, when you will have the option of handing back the car instead of paying it.

When you set up your PCP, you will be given a minimum guaranteed future value (MGFV) and this will be deferred to the end of the contract. You will make low monthly payments during the term of the agreement, before having the choice of whether to make a final payment (also known as a balloon payment) equivalent to the MGFV.

If you pay, you will own the car outright. Alternatively, you could return the car or use the equity you have in the vehicle as a deposit for a new model.

One thing to be aware of is that PCPs involve agreeing a mileage limit, which is used to calculate the MGFV. If you exceed the figure, you will incur additional costs.