Car finance glossary

Agreement

A finance agreement is a contract between the lender (the finance company) and the borrower (you).  It is legally binding, and sets out the exact schedule of payments for the loan.  It also sets out all interest, fees and charges, as well as your rights and responsibilities.

Do not sign an agreement unless you agree to be legally bound by all of its terms and conditions. Check carefully to make sure that all of the numbers are the same as you have been quoted. If you have any questions, make sure they are answered to your satisfaction.

If you are unsure of anything, get a second opinion or keep asking questions until you are comfortable with the answers.  Far too many people sign documents they do not fully understand, which can have expensive consequences.

Amount of Credit

The amount of money being loaned to you by the finance company. In other words, the amount you are borrowing.

This is not the same as the Total Amount Payable, which is the amount you have to pay back and includes the amount of credit plus any interest and fees.

APR (Annual Percentage Rate)

This is an overall figure which shows the annual cost of borrowing the money.  It includes all the interest and scheduled fees payable as part of the agreement.

This is a government-mandated calculation, which allows you to compare different finance offers to understand the total cost of borrowing (for example, Offer A may have a low interest rate but high fees, and Offer B may have a high interest rate but low fees).

All PCP, HP, conditional sale and LP agreements must clearly show the APR on all quotes, agreements and other documentation (eg – marketing material).

Arrears

Arrears simply means ‘behind’.  Monthly car finance payments are usually taken ‘in arrears’, so your first direct debit payment is usually taken from your account a month after you take delivery of the car rather than up front.

If your account is ‘in arrears’, it means you are behind your payment schedule and will have to pay extra to get back to the agreed plan.

Balance

A net amount, after any payments or charges are counted.  For example “Your account balance is £4,258.56”.

A negative balance is an amount you owe, a positive balance is an amount you have available or that you are owed.

Balloon

A lump sum payable at the end of certain finance agreements like a PCP.

In some types of finance agreement, it is also known as an Option to Purchase Fee. In a PCP, the balloon/Option to Purchase Fee amount is equal to the Guaranteed Future Value (GFV). This means you either give the car back (since its value is equal to what you owe), or you pay the balloon and keep the car.

A Hire Purchase with a balloon payment is called a Lease Purchase (LP).

You should also read: What are your options at the end of a PCP?

Charge

See Fee.  The words fee and charge are generally used interchangeably by most companies, although some will define a slight difference.

A charge is usually a specific type of fee which is triggered by an action in the agreement (eg – a penalty charge imposed for not making payment on time).

A fee is a payment associated with a service (eg – an administration fee for setting up an agreement)

Conditional sale

A conditional sale is very similar to a hire purchase. The interest rate is fixed for the full term, and the amount borrowed is spread equally into monthly payments until the Total Amount Payable is repaid.

The loan is secured against the car, so ownership remains with the lender until the finance is fully repaid. Once that happens, ownership automatically transfers to the borrower.

The agreement must be settled in full before you can sell the car, or as part of the sale if you are part-exchanging the car at a dealership.

Contract

see Agreement. A contract is a legally binding agreement between the lender (the finance company) and the borrower (you).  It sets out the exact schedule of payments for the loan, as well as all interest, fees and charges, as well as your rights and responsibilities.

Do not sign a contract unless you agree to be legally bound by all of its terms and conditions. This is especially important for finance agreements, as they will typically last 3-6 years and it is difficult to know what your circumstances will be that far into the future.

Contract Hire

a Lease or long-term rental agreement.  It is essentially not very different to renting a car for a day or a week. You do not own the car; it remains the property of the finance company at all times.  At the end of the agreement, the car goes back to the finance company, just like a rental car.

Popular with businesses and with company car drivers, advertised monthly payments do not normally include VAT.  If the vehicle is used for business purposes, you may be able to claim part or all of the VAT back.

You should also read: Personal contract hire (PCH) explained.

Credit Rating / Credit Score

An assessment of your suitability to borrow money.  There are several agencies that rate your credit worthiness (eg – Experian, Equifax), and the finance company or bank will usually refer to one or more of these agencies for information about your credit record.

Your credit rating is affected positively by you paying your bills on time and repaying all money owed in accordance with your agreements.  It is affected negatively by you failing to make payments or having too many finance obligations on your plate to be considered for any more credit.

Default

To default on your finance agreement is to miss a scheduled payment, usually a monthly instalment.

Defaulting on your agreement is a breach of your contract, and means that the finance company can take action against you in response.

Most finance companies will not penalise you if you default once on your agreement, as long as you make up your arrears. However, if you repeatedly default or fail to get your account payments back into order, you will be in trouble.

Deposit

An up-front or initial payment. It’s a bit of a misnomer because it is not usually refundable if you cancel. It is not a bond.

A deposit is only usually refundable if the contract cannot go ahead (for example, your finance application was rejected, or the vehicle you wanted was not available) or if the contract specifically states that it is subject to any conditions (eg – passing an independent mechanical inspection) which are not met.

Many people think that they get the deposit amount back at the end of a PCP agreement. Again, this is not true. It is an up-front payment towards the cost of the vehicle.

Deposit Contribution

A form of discount or incentive offered by a manufacturer or finance company or dealer which is conditional on taking the finance offer. Technically the dealer/manufacturer/finance company is giving you money towards the cost of the car, rather than reducing the cost of the car by the same amount.

You should also read: The Car Expert’s guide to deposit contributions.

Depreciation

The amount of money your car loses as a result of VAT, age, mileage, wear & tear and so on. The value of your car after depreciation is called the residual value.

You should also read: The Car Expert explains depreciation.

Early Settlement

Also called redemption. If you want to sell your car or pay off the finance before the end date of the finance agreement, this is called an early settlement.

Settling the agreement early will usually save you money overall, as you pay less interest on your borrowing – although there may be a charge involved.

You should also read: The Car Expert’s guide to settling a finance agreement early.

Equity

The difference between what your car is worth and what you owe to the finance company. ‘Positive Equity’ or simply ‘equity’ means your car is worth more than what you owe (eg – if your car is worth £10,000 but you still owe the finance the finance company £8,000, then you have £2,000 of equity).

Negative equity means your car is worth less than what you owe, so there is a shortfall that needs to be paid off in order to sell or part-exchange the vehicle (eg -if your car is worth £6,000 but you still owe the finance the finance company £8,000, you have £2,000 of negative equity).

Excess Mileage

Certain types of finance agreement, like a PCP or Contract Hire, will have a mileage allowance for the total duration of the term.

If you have exceeded your mileage allowance at the end of the agreement, you may have to pay a penalty charge (usually about 10-20 pence for every mile over the allowance).

Fair Wear and Tear

If you are giving the car back to the finance company or have a Guaranteed Future Value on the vehicle, then it is fair for them to expect the car to be in good condition when they take it back.

Obviously a car will suffer a degree of wear and damage simply by driving around on the roads for a few years, so a certain level of wear and tear is acceptable.  However, damage beyond ‘normal’ will have to be paid for.

It’s difficult to define exactly what is fair and what is not, so be prepared to argue with the finance company over any charges they want to impose on you.

Fee

Also see Charge. An amount of money payable in one lump sum.

Nearly all finance agreements will have fees payable at the start of the agreement, and most will also have fees payable at the end. Keep this in mind when planning your monthly budget, as your first and last payments could be much larger than all the others.

There may also be penalty fees or charges payable if all the conditions of the agreement are not met (for example, if you don’t keep up with your monthly payments, exceed your mileage allowance  or want to settle the agreement early).

FCA

Financial Conduct Authority. The independent regulatory body responsible for regulating all consumer credit agreements in the UK since April 2014, succeeding the FSA (which was abolished) and taking over responsibilities from the Office of Fair Trading.

Car finance agreements fall under the jurisdiction of the FCA.

Not to be confused with Fiat Chrysler Automobiles, a large Italian-American car manufacturer that also uses the acronym FCA.

Fixed rate

A fixed rate finance agreement means that the interest rate will remain the same for the whole term, rather than going up or down at different times. This means that your monthly payments will remain the same for the whole term of your agreement.

Flat rate

See interest rate. The percentage you repay the finance company over and above the money you are borrowing. Car dealers often refer to the flat rate instead of the APR because it’s almost always lower, but don’t be fooled.

FLA

Finance and Leasing Association. A lobby group that advocates on behalf of its members – the finance companies – in the media and to government.

Dealers will often talk about being FCA compliant, when they actually mean complying with self-regulated behaviours agreed by finance companies that are co-ordinated by the FLA. This is not the same thing.

The FLA runs a training and testing programme called SAF (Specialist Automotive Finance), which accredited dealers follow to show that they are meeting FCA requirements for the sale of finance products.

FSA

Financial Services Authority. The predecessor of the FCA (see FCA, above), abolished in 2013.

Some dealers and finance advisors may still refer to the FSA out of habit, but all written information must be up to date with appropriate references to the FCA.

GAP Insurance

An optional, additional insurance which covers you above and beyond your car insurance payout in the event of a total loss claim on your car (ie – stolen and not recovered, or written off in an accident).

GAP insurance covers you for the difference between the car insurance payout and either the finance settlement or the original invoice price of the car.

Car dealers will always try to sell you GAP insurance because they make lots of profit out of it.  However, you should decide if it’s right for you before agreeing to take it.

You should also read: What is GAP insurance and do you need it?

GFV / GMFV

Guaranteed (Minimum) Future Value. In a PCP agreement, the finance company guarantees a minimum value for the vehicle at the end of the agreement, based on the length of the term and the total mileage to be covered.

It assumes the car is in good condition (see Fair Wear and Tear) and has a full service history.  If you do not meet these conditions, the finance company will not be required to pay you the GFV.

The GFV is equal to the Option to Purchase Fee (balloon) you have to pay if you want to keep the car.

You should also read: What are your options at the end of a PCP?

Guarantor

If you do not meet the finance company requirements for lending, they may require a guarantor to commit to making the payments if you fail to do so.

Usually this applies to young people with little credit history to show, although it may also be required for someone with a poor credit rating or history. However, these days finance companies are more likely to simply reject an applicant with poor history rather than bother with a guarantor.

If you are a guarantor for someone else, you are signing a legally-binding contract to the finance company to take on the payments if the borrower stops paying for any reason. The borrowing will probably be noted on your credit score, so it may affect your ability to borrow any other money in your own name.

Halves

Also see Voluntary Termination. Once you have repaid half of the Total Amount Payable on an HP or a PCP, you are entitled to return the car without any further payments.  You must have had a perfect payment history and the car must be in good condition (see Fair Wear and Tear). Your credit rating will not be affected.

You should also read: The Car Expert’s guide to Voluntary Termination.

HP (Hire Purchase)

The Hire Purchase is a popular and straightforward finance agreement.  The interest rate is fixed for the full term, and the amount borrowed is spread equally into monthly payments until the Total Amount Payable is repaid.

The loan is secured against the car, so you do not take legal ownership until the finance is fully repaid.  This means the agreement must be settled in full before you can sell the car, or as part of the sale.

You should also read: The hire purchase explained.

Instalment

A scheduled payment.  Usually in reference to a regular monthly payment.

Interest

The money payable on top of the amount borrowed. Interest is effectively spread over the entire term of the agreement, so you pay an amount of interest in every individual monthly payment.

This is different to a fee, which is payable in one lump sum.  So £1,000 in interest is paid in many small payments, but a £1,000 fee is paid in one hit.

Interest Rate / Flat Rate

The percentage you repay the finance company over and above the amount borrowed. This is different from an APR, which also includes fees.

On car finance agreements and most personal loans, the interest rate is fixed over the entire term of the loan, so your payments should not change during the life of the agreement.

For a given interest rate, you pay more interest as the term gets longer – for example, you will basically pay double the amount of interest over four years than you would over two years. This means that although your monthly repayments will be lower, you will actually be paying more money in total for the car.

Invoice Price

The price of the car, including VAT but not including on-road costs such as Vehicle Excise Duty (aka road tax). Often used in insurance claims, which usually don’t cover on-road costs.

Bear in mind that you will have to pay additional costs over and above the Invoice Price to legally get the car on the road.

Lease

A rental (see Contract Hire). With a lease, the finance company retains ownership of the vehicle at all times and you must give the vehicle back to them at the end of the lease period.

There is usually no option to purchase the vehicle outright at any point.

LP (Lease Purchase)

Not very popular in the UK these days, an LP is a form of HP whereby you defer a large payment (balloon) to the end of the agreement.

The difference between an LP and a PCP is that there is no guarantee on the future value of the vehicle. You simply pay the balloon amount at the end of the agreement, or cross your fingers that the car is worth more than the balloon amount.

You should also read: The Car Expert’s introduction to car finance.

Logbook Loan

A form of loan whereby you sell your car (which must not have any finance already on it) to a finance company, who then rents it back to you.

It is not a method of buying a car, but a cash loan using your car as security and aimed at people who cannot get a personal loan from a bank due to a poor credit rating. In some cases, the lender does not even check your credit rating, as they own the car and can repossess it at any time.

You have the right to buy it back from the finance company at the end of the agreement. Usually a sub-prime and short-term type of finance, it is strongly discouraged under any circumstances.

You should also read: The Car Expert’s article on logbook loans.

Maintenance

Many lease agreements include the option to include your car’s servicing costs in the monthly payments, saving you the need to pay for those costs separately.

It may not save you any money overall, and can actually increase your total costs, but it does mean you can spread the servicing costs over the whole term rather than paying them in large chunks whenever they appear.

Mileage Allowance

A finance agreement which involves the finance company taking the car back at the end of the term, like a PCP or Contract Hire, is calculated based on the end value of the car.

This value will depend on the mileage (for example, a 3-year-old car with 30,000 miles on the clock will be worth more than a 3-year-old car with 60,000 miles on the clock). You nominate the annual mileage you expect to cover to calculate the total mileage allowance.

If you exceed this mileage allowance at the end of the agreement, you will be charged a penalty fee (usually about 10-20 pence for every mile over the allowance).

Negative Equity

Also see Equity. The difference between what your car is worth and what you owe to the finance company.

‘Negative equity’ means your car is worth less than what you owe, so there is a shortfall that needs to be paid off in order to sell or part-exchange the vehicle (eg – if you owe the finance company £8,000 but your car is only worth £6,000, you have £2,000 of negative equity).

Some finance companies will allow you to finance a certain amount of negative equity as part of your new finance agreement, but it is far from ideal as you are almost certainly setting yourself up for further trouble down the road.

You should also read: The Car Expert’s guide to negative equity.

On-Road Price

The total price of the vehicle, including Vehicle Excise Duty (aka road tax), number plates and any delivery costs.

In countries other than the UK, this may include local taxes or stamp duties which need to be paid prior to taking delivery of your vehicle.

Basically it is the total cost to get the car “on the road”, as opposed to the Invoice Price which may not include any additional costs.

Option to Purchase Fee

Usually associated with a PCP, this is the balance outstanding at the end of the agreement that you have to pay to settle the finance agreement and take ownership of the car (since it still belongs to the finance company).

On a PCP it is an equal amount to (but technically not the same thing as) the GFV.

You should also read: What are your options at the end of a PCP?

Overpayment / Additional Payment

Certain finance plans or finance companies allow you to make extra payments on top of your regular monthly payments.

This can reduce your Total Amount Payable and/or shorten the Term and/or lower your Monthly Payment amounts.

Beware that some finance companies will charge you a penalty fee for doing this, which would decrease any savings made.

Personal Loan

A Personal Loan is a form of unsecured loan.  Money is lent to you without any guarantee or security, and you are free to spend it as you like.

In terms of buying a car, you use the money borrowed in the loan to purchase a car outright, unlike a secured loan like an HP or PCP where the finance company owns the car.

This means that if you stop making your monthly payments, the finance company cannot repossess your car (it’s yours, not theirs), but they can seriously damage your credit rating and even force you into bankruptcy.

PPI (Payment Protection Insurance)

A type of insurance designed to cover you in the event of you being unable to make your regular monthly payments.

PPI has been in the news regularly over the last few years due to banks and other financial institutions mis-selling the product, either by selling it to people who were not eligible to ever claim on the product, or including it in their payments without explaining it or actually asking the customer if they wanted it.

Payment Protection Insurance can be very difficult to claim on, and is not popular with car finance products.

PCH (Personal Contract Hire)

See Contract Hire; a lease or long-term rental agreement. It is essentially not very different to renting a car for a week.

You do not own the car; it remains the property of the finance company at all times.  At the end of the agreement, the car goes back to the finance company, just like a rental car.

Personal Contract Hire is aimed at individuals rather than companies leasing the vehicle. Monthly payments may be quoted either excluding or including VAT, so you should check to make sure.

You should also read: Personal Contract Hire (PCH) explained.

PCP (Personal Contract Purchase)

May also be referred to as ‘Personal Contract Plan’. The most popular way for private individuals to finance a new or used car in the UK for personal use.

Most manufacturer finance companies will have their own name for their PCP offerings (eg – Volkswagen Solutions, BMW Select).

A PCP is a form of Hire Purchase, but instead of repaying the entire cost of the vehicle, you only repay the depreciation.

At the end of the agreement, you can either pay out the remainder (the Option to Purchase Fee or balloon) or give the car back to the finance company. You can also sell the vehicle, providing you pay out the Option to Purchase Fee before signing the logbook over to the new owner.

You should also read: The PCP (Personal Contract Purchase) explained.

Pre-Contract / Pre-Credit Contract Information

A summary of the main points of a finance agreement. Any seller of finance (usually the Business Manager at the dealership) is required to give you this document to read and understand before you are presented with the finance agreement itself (the contract) to sign.

You are entitled to take it away to read at your leisure, although most dealerships will do their best to gloss over this and get your signature on a contract as quickly as possible.

Don’t be pushed around. Read every document carefully before signing, because they are legally binding and it’s not easy to change your mind down the track.

You should also read: The Car Expert’s article on Buyer’s Remorse.

Quote / Quotation

All car finance offers must be available in writing, and provide all relevant information clearly in a format regulated by the FCA.

It is not enough for a dealer to say “it will cost £X over £Y months” – they must give you a complete breakdown on an official written quotation from the finance company. Make sure you have this and understand every aspect of it before you agree to anything.

A quote (or “quotation”) is not legally binding, and a finance company may reject an application because the dealer has not provided a quotation that meets their requirements. However, a dealer cannot mis-sell a finance offer by quoting a payment that he/she knows is not available or achievable and has no intention of honouring.

A quote should also specify how long it is valid for (usually 14 days).

Re-finance

With a PCP or Lease Purchase, you have a balloon amount at the end of the agreement which needs to be settled. Some finance companies (but not all) will allow you to extend the finance to pay off the remainder, or to start another agreement to pay it off.

However, this will mean paying additional interest and fees on top of what you have already paid (you have already paid interest on the balloon payment), so it can be very expensive in terms how much you eventually pay to own the vehicle.

Redemption

See early settlement.

Redemption is the settlement of your finance agreement by paying off the outstanding amount, usually before the scheduled end date.

Residual Value

The value of a used car at a particular point in its life, taking into account its age, mileage and condition.

Finance companies need to be able to predict the value of a car at the end of the agreement, for whatever term and mileage your contract states. So they have formulae to calculate the depreciation of your new car over one year, two years, three years and so on. These values are called residual values, as they predict how much of your current car’s value will remain over time.

SAF (Specialised Automotive Finance)

A training and testing programme created and managed by the FLA to try and ensure sales staff at car dealerships are compliant with FCA regulations about selling finance.

The programme is self-regulated, rather than controlled by the FCA. It’s also easily cheatable and basically relies on the honour system rather than any external oversight.

Secured Loan

A finance agreement where the car is secured by the finance company (it remains their legal property until the finance is settled in full).

If you stop making payments, the finance company can take action to repossess the vehicle (although there are legal conditions and limits; see Thirds). They will then sell the car at a trade auction and can then come after you for any debt still outstanding.

An unsecured loan means that the finance company cannot repossess your car as it is your property.

PCPs and HPs are examples of secured loans, where the car remains the legal property of the finance company until the finance is settled in full.

Settlement

A payment to cover all outstanding money owed and end the agreement.

Term

The repayment period, usually expressed in months on a finance agreement. Most car finance agreements are usually anywhere from 12-60 months (1-5 years).

Thirds

In a secured loan, the finance company has the right to repossess your car if you stop making your monthly payments. However, once you have repaid a third of the Total Amount Payable, they can’t do this unless they have a court order.

You don’t want to get to a point where the finance company is going to court to try to seize your car, so if you are having trouble with your finance payments, contact the finance company immediately and work with them rather than against them. You’ll end up much better off (or rather, less worse off).

Total Amount Payable

The total cost of the vehicle, including your deposit, the amount of credit, interest and all scheduled fees.

This is the figure that shows you how much it really costs to finance the vehicle. The Total Amount Payable minus the On-Road Price = the total cost of the financing the car.

Unsecured Loan

A loan where money is lent to you without any guarantee or security, unlike a secured loan (eg – HP or PCP) where the loan is secured against the vehicle.

This means that if you stop making your monthly payments, the finance company cannot repossess your car (it’s yours, not theirs), but they can seriously damage your credit rating and even force you into bankruptcy.

A Personal Loan is a form of unsecured loan.

Variable rate

A variable rate finance agreement is unusual in car finance, unlike property finance. With a variable rate agreement, the interest rate can increase or decrease over the term of the agreement depending on what official interest rates are set by the Bank of England. This means your monthly payments will increase or decrease accordingly.

Voluntary Surrender

Voluntary Surrender is very different to Voluntary Termination (below) and, basically, much worse for the borrower.

If you can’t afford to make your monthly payments on a Secured Loan like a PCP or HP, you can agree to let the finance company take back their car and sell it at a trade auction. This usually won’t recover enough money to pay what you still owe, which means they will then come back after you for whatever’s left, plus any additional fees they feel like adding.

Voluntary Surrender is very much a last resort if you really can’t make your payments

Voluntary Termination (VT)

Once you have repaid half of the Total Amount Payable on an HP or a PCP, you are entitled to return the car without any further payments.

You must have had a perfect payment history and the car must be in good condition (see Fair Wear and Tear). Your credit rating will not be affected.

You should also read: The Car Expert’s guide to Voluntary Termination.

Wear and Tear

See Fair Wear and Tear

Car finance glossary last updated October 2021.