Key terms to understand before getting a car loan

September 10, 2024

As a trusted car loan specialist, we always take the time to ensure you fully understand our offers and contracts. However, getting to know some of the common loan document language in advance can make it easier for you to ask questions and compare different offers. There are also some terms you’re likely to hear in conversations about car loans in general. To get you up-to-speed quickly, here’s a short guide to car loan jargon.

Interest rate

When you get a car loan, you agree to pay the money back plus some extra, known as interest. This is how the lender makes their money as a business. Interest is calculated as a percentage of the amount you still owe (the principal). The interest rate will depend on market rates when you apply for the loan and how much risk there is that the lender might not get their money back if things go wrong. With a car loan, your agreed interest rate is usually the same (fixed) for the life of the loan.

Loan term

This is the time you have to repay the loan in full. You can usually choose anything from six months to five years. Choosing a longer term will spread your payments out, so they’ll be smaller each time. However, you’ll pay interest for longer, which means you’ll end up paying more over the life of the loan. Also, your car will usually have less resale value by the time it’s paid off.

Deposit

Also known as a down payment, this is the amount you contribute towards the purchase of the car. It’s often described as a percentage of the price. So a $2,000 deposit on a $10,000 car means a 20% deposit and an 80% loan. A higher percentage deposit means there’s less risk of the lender not getting their money back if you can’t keep up the regular payments, so it might mean a lower interest rate. On the other hand, a no-deposit or low-deposit loan is likely to come with a much higher interest rate.

Loan payment

To make budgeting easier, your weekly, fortnightly or monthly car loan payments are normally calculated to be the same each time. At the beginning of your loan, each payment is mostly made up of the interest owing. As you gradually repay the loan, your regular payments include less interest and repay more of the amount you owe (the principal).

It’s often a good idea to choose a loan payment frequency that matches your pay cycle. That way your loan payment will be one of the first things you cover, i.e. there’s less chance of accidentally over-spending and having to miss a payment.

Total cost of finance

This is how much the loan will cost you overall. It includes the loan amount, the total interest you’ll end up paying over the life of the loan and all standard fees the lender intends to charge. It’s a very important number to consider when comparing loan options.

The lender will normally state the total cost of the loan in their written offer. If they don’t, be sure to ask for it in writing.

Early repayment charges

With some car loans, if you make extra payments or pay your loan off in full before the agreed term ends, you’ll be charged an early repayment fee. Other car loans don’t come with early repayment fees. They’ll let you make extra payments or repay your loan earlier without any penalties.

Be sure to ask about early repayment charges when comparing loan offers. If you get the chance to repay your loan sooner, without paying a penalty, it can significantly reduce the interest you pay over the life of the loan.

Other fees and charges

Most lenders charge administration fees to set-up, operate, change and close-out a car loan. Some will be standard fees that apply to every loan they provide, such as a set-up or establishment fee. Others will only be charged if you request or trigger a particular process, such as changing your payment schedule or increasing the amount you’ve borrowed. The standard fees should be included in the total cost of finance your lender provides. But it’s important to ask for a list of all fees, so you know what you might be charged if things change.

Interest-free and no repayments periods

These ‘special offers’ of no interest and/or no repayments for the first months are sometimes used to attract customers or win your business. If they save you money, or provide a more suitable loan for your situation, that’s great. Just be sure to check and compare the total cost of the loan, as well as the schedule of fees and charges. Sometimes the lender will recover the interest lost in the first few months by charging a slightly higher interest rate for the many months or years that follow. You might end up paying more overall.

Default interest rate

If you miss a payment or fall behind in your repayment schedule, you’ll be charged extra interest on the outstanding amount (arrears) until your balance is back to where it should be. The extra interest is charged at a default interest rate, which should be specified in your loan document or contract. It’s usually something like the loan’s interest rate plus 5%.

Default interest only applies to the amount that’s in arrears (behind schedule). It’s usually calculated daily using the annual default interest rate divided by 365. The daily interest charges are added to your loan balance, usually each month. This can put you further into arrears if you haven’t caught up yet.

If you think you might miss a payment it’s important to contact your lender beforehand. They may be able to offer a solution that avoids paying default interest.

Secured loan

A secured loan gives the lender something they can sell, as a last resort, to get their money back if you can’t continue your regular loan payments. With a car loan it’s usually the car itself. If they repossess the car and sell it, they’ll use the money to repay the amount still owing, plus any reasonable fees and charges, then give you anything that’s left over. Secured loans have a lower interest rate than unsecured loans, because there’s much less risk of the lender losing money.

Comprehensive car insurance

When the car is included as security for a loan, you normally have to get comprehensive (full) car insurance. This protects the lender’s security if the car is stolen or damaged in an accident. Comprehensive vehicle insurance is more expensive than third party-only cover, and the cost will depend on the type of car and age. It’s a good idea to get insurance quotes for the type of car you’re considering before you start shopping around. It can help you narrow down your search and avoid wasting time on cars that would end up being too expensive to insure.

Payment protection insurance (PPI)

This optional type of insurance covers your loan payments if you can’t work due to specified events, such as redundancy, illness or injury. These policies usually have an adjustable wait period before cover payments start, as well as an agreed maximum time the loan payments will continue. Loan protection insurance is similar, but it’s designed to repay the loan in full in certain circumstances. Income protection insurance is another option; it pays out to you, rather than the lender.

Having your payments protected in some way by insurance is not compulsory. While it might reduce your loan’s interest rate and give you more peace of mind, there’s a cost involved. It pays to carefully consider whether the potential benefits outweigh the added cost.

If a lender offers to add the cost of insurance to your loan, remember that you’ll pay interest on that amount for the entire life of the loan.

Disclosure statement

Lenders are legally required to give you a written disclosure statement that includes the agreed interest rate, how the interest will be calculated, what happens if you can’t make the scheduled payments, and a list of all potential fees and charges related to the loan. It’s important to read the disclosure statement carefully and ask questions or get independent advice if there’s anything you don’t understand.

Credit score

When you apply for a loan, the lender will check your credit history and credit score. This is a record of how well you have managed credit finance in the past. It includes things like loans, mortgages, credit cards, store cards, buy-now-pay-later accounts and utility bills. Your credit history and score are available online to you; they’re also available to registered financial service providers and utility companies. You can check your credit records online for free at My Credit File, Centrix or Illion. The New Zealand government website has more on how to check your credit record.

Next steps

Now that you have a deeper understanding of car loan language, it’s time to find the right loan for your needs. Whether you’re just getting started or you’ve already found a suitable car, Auto Finance Direct is ready to help. We make it quick and easy to get a quote and apply for your loan. You can do this through many vehicle dealerships in New Zealand or apply online now.

DISCLAIMER: This article offers general information and is not intended as financial advice. While the information is verified, it is meant to educate about vehicle finance options in New Zealand. The article does not suggest any particular strategy, loan type, or vehicle finance service as suitable for any individual. We cannot assess your unique personal circumstances, finances, or objectives. It is advisable to seek professional financial advice from an authorized adviser before making any financial decisions.