A simple guide to understanding car financing

If it's your first time making a big purchase, you may need a quick run-through of how financing works. Your car dealer will be happy to make the complicated aspects of your loan agreement more understandable, but if you want to be prepared beforehand, we've got you covered.

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What does financing mean?

Financing refers to when you buy a car using credit. Unlike leasing, this means you actually own the vehicle from the start. Typically, you borrow the money from a bank, credit union or from the dealership itself.

Interest rates

When you finance a vehicle, you receive the loan in one lump sum, which you pay back over time plus interest. The interest rate will depend on a few factors, including your credit score.

Length of term

This refers to the length of time for which the loan lasts. Usually lasting somewhere between 36 to 72 months, your payments will be lower if you choose a longer option and the opposite if you have a shorter time frame—these are your repayment terms.

Credit agreement

Much like when using a credit card, when you finance a car, a credit agreement is struck between the buyer and the lender. This determines the interest rate and payback period and must be signed by you to receive your car loan.

Credit (or loan) amount

This refers to the total credit amount on a loan for a car; it’s the amount you will receive for the loan once the arrangement fees have been paid.

Credit costs

The credit cost is an expression of the total price you will pay to borrow money for financing a car. This includes the sum of interest, fees, etc., to give a complete cost of the loan as a cash amount.

Monthly payment

The monthly payment is the full amount you pay to the loan provider each month that is agreed upon. Not only does this include the installments of the borrowed amount but also the arrangement fee and interest.

Arrangement fee

This refers to a one-time amount that you pay to set up the car financing. Typically, this fee is added to the monthly payments and represents a number of costs incurred by the loan provider.

Credit reference agency

A credit reference agency is a company that collects information about individuals and their credit histories. This information is then used in the agency’s credit assessment of a person, which will determine the amount of money that banks and other financial institutions will be willing to lend them.

Annual percentage rate

The annual percentage rate (or APR) is the interest rate on a loan for a whole year. APR is commonly used to compare the costs of different loans over a period of time.

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