Auto Leasing Terminology
Taking the mystery out of auto jargon.
Below is a list of terms relating to vehicle leasing and purchasing.
Terminology
Annual percentage rate (APR)
The effective interest rate paid on a loan, expressed as an annual rate. APR measures the true cost of borrowing by including any fees or prepaid interest involved in obtaining a loan. For instance, if a borrower pays $500 in closing costs to obtain a $10,000 loan, the APR is higher than the simple interest rate because the borrower is repaying a $10,000 loan but only receiving net proceeds of $9,500. The federal Truth-in-Lending Act requires lenders to disclose the APR.
Advertising fee
A fee that an auto dealer charges an auto buyer to pay for advertising costs
Average cost per year
The net cost of owning a car divided by the number of years owned. To calculate net cost, subtract the car’s expected trade-in value, any amortized loan principal, and rebates received from the non-operating costs of owning a car. Non-operating costs include interest paid on a loan for the car, depreciation expense (wear-and-tear), and the trade-in value of the car used to help pay for the replacement vehicle.
Amortization
The gradual reduction of debt that occurs as loan payments are applied to loan principal and interest at a rate that repays the loan principal by the end of the loan term.
Appraisal
An opinion rendered by a certified professional of an asset’s market value as of a specific date.
Base price
The cost of a car without options, but including standard equipment, factory warranty, and freight. This price is printed on the Monroney sticker.
Capitalized cost
Amount financed under a lease agreement.
Capitalized cost reduction
A leasing term synonymous with cash down payment or other consideration made at the beginning of the lease term, such as a trade-in.
Closed-end lease
A lease agreement that establishes a non-negotiable residual value for the leased auto and fee amounts due at the end of the lease term
Cost analysis
A means of evaluating multiple choices and identifying the low-cost alternative using financial principles. In some cases, a cost analysis is done as a “net cost analysis,” which means that the benefits are also included in the analysis.
Dealer charges
Amounts charged for features sold separately by auto dealers, such as rust-proofing, undercoating or services offered in extended warranties.
Dealer holdback
An allowance auto makers give dealers that is worth about two to three percent of an auto’s MSRP. A holdback allowance allows a dealer to pay the maker an amount less than the invoice. This allows the dealer to record a profit by suggesting he paid invoice price for the auto when, in fact, he has paid less.
Dealer incentives
Programs offered by auto makers to boost sales of less popular models and reduce inventories. Dealers decide whether to pass the savings to customers.
Dealer invoice
Amount that auto makers charge dealers for vehicles, including options.
Dealer sticker price
The Monroney sticker price plus a suggested markup for dealer-installed options.
Depreciation
The annual reduction in the value of an asset attributed to normal wear and tear. Depreciation is based primarily on miles driven. The greater the miles, the greater the depreciation. Annual depreciation rates for autos are also influenced by vehicle model, maintenance, general consumer demand for the model, and the maker’s reputation for quality. Luxury cars retain their value longer and, hence, depeciate more slowly. Depreciation expense is used to calculate the residual value for preparing closed-end leases.
Destination charge
A fee not marked-up by the dealer that is paid by the consumer for shipping and dealer-delivery costs of an auto.
Down payment
Amount paid by the consumer in cash or trade-in value in order to obtain an auto loan to finance the remainder of the purchase price
Escrow
A process handled by a third-party fiduciary agent that involves depositing and disbursing funds for buyer and seller in a neutral account. The escrow agent’s role is to protect either side of a transaction from the other side’s unauthorized use of funds and to ensure an arms-length transaction between buyer and seller.
Gap protection
Insurance that covers the amount owed due to early termination of a lease agreement. Such early termination may occur when a car is stolen or seriously damaged in an accident. However, the auto insurer’s payment may not be enough to pay off the lease balance and any early-termination penalties.
Gross income
Total income, before taxes or deductions. Gross income is one of the factors lenders weigh when they review loan requests.
Home equity line of credit
A revolving credit facility, collateralized by a mortgage lien, that allows a homeowner to borrow against the equity in the home.
Home equity loan
A fixed- or variable-rate loan, collateralized by a mortgage lien, that allows the homeowner to borrow against equity in the home for funds to pay for repairs or other home improvements, refinance other debt or use for other purposes. Unlike a home equity line of credit, home equity loan term and payment amounts are fixed.
Invoice price
The auto maker’s base charge to a dealer, which includes a freight charge (often called a destination or delivery charge).
Interest rate
The cost of borrowing money or the rate of return earned on lending money, expressed as an annual rate. Interest rates can be calculated as simple, compounded or effective.
The simple interest rate is sometimes referred to as the “stated” interest rate. It is the amount of interest paid at the end of the loan term divided by the loan amount. For instance, $100 in interest on a one-year loan of $1,000 paid at the end of the term equals a simple interest rate of 10 percent.
The compounded interest rate is determined by the frequency of interest payments during a loan or deposit term. Consider the same one-year loan of $1,000, with compounded interest paid in equal intervals over the term. The $100 in interest is made in four payments of $25, once every three months. The interest payments can be reinvested by the lender sooner, allowing him to earn more interest. The same one-year loan of $1,000, compounded four times a year, equals a compounded rate of 10.38 percent. If compounded daily, the compounded interest rate increases to 10.52 percent. For depositors, this compounding produces the annual percentage yield (APY).
The effective interest rate is also called the annual percentage rate (APR). It measures the true cost of borrowing. The effective interest rate includes any fees or prepaid interest paid to obtain a loan. For instance, if a borrower pays $50 in closing costs to obtain the same one-year loan of $1,000, the effective rate will be higher than the stated or compounded interest rate. This is because the borrower is repaying a $1,000 loan but only receiving net proceeds of $950.
Lien
A legal claim recorded against an asset—a home or auto, for instance—by a creditor to collateralize a loan.
Loan application
A preliminary step in obtaining a loan. A loan application tells the lender how much the applicant wishes to borrow and how the loan proceeds will be used; lists personal income and assets; describes work history; and authorizes the lender to receive a credit report to assist in making a lending decision.
Loan-to-value ratio
Loan-to-value ratio (LTV) is the loan amount divided by the value of the collateral that secures the loan. The collateral value is determined by either an appraisal or recent arms-length transaction. For instance, an $80,000 loan on a home that was recently appraised at $100,000 has an LTV of 80 percent.
Lock-in
Also called a rate lock, a lock-in is a lender’s commitment to make a loan at a pre-set interest rate for a pre-set number of days. A rate lock protects borrowers against interest rate increases, and shifts the risk of changes in market interest rates to the lender.
Manufacturer’s rebate
A money-back program that auto makers offer consumers directly to boost sales of less popular models and to reduce inventories.
Money factor
A leasing industry term that is synonymous with interest rate.
Monroney sticker price
Label affixed to the window of an auto that discloses the auto’s base price, installed options, MSRP, freight charge, and fuel economy (mileage). Federal law mandates these minimum labeling requirements and prohibits the sticker’s removal by anyone other than the buyer.
MSRP
Acronym for Manufacturer’s Suggested Retail Price, which is an auto’s recommended selling price. Most options are not included in the MSRP.
Open-end lease
A lease term that requires the lessee to pay the difference between residual value and fair market value at the end of the lease term if the fair market value is lower.
Preparation charges
Charges imposed by a dealer for preparing a newly purchased auto for delivery to the buyer. These include fueling and servicing the auto and any cosmetic changes made just prior to sale.
Qualified nonpersonal use vehicle
One that is not likely to be used more than minimally for personal purposes because of its design
Rate changes
Periodic resetting of the interest rate on a line of credit or fixed-rate loan. Often, the base rate is a widely used rate such as the prime rate—the rate the largest U.S. banks charge their best customers.
Reconditioning reserve
An auto leasing term synonymous with security deposit. The lessee gives the lessor a reconditioning reserve in the event a leased auto’s condition deteriorates to a point where reconditioning is necessary.
Residual value
The remaining dollar value of a leased auto at the end of the lease term. Residual amount is synonymous with book value, which is the remaining value of a fixed asset after deducting depreciation expense.
Revolving credit
A form of open-ended credit in which a borrower can draw down on the credit line for the amount of the limit, repay at least some of the loan, and then draw down on the line again up to the limit amount. In some cases, periodic minimum payments or cleanup periods—paying down the disbursed amount to zero—are required by the lender to ensure that the borrower has the financial capacity to repay the line.
Savings rate
The percentage of gross income that is saved or invested.
Tax rates
The percentage of income paid in income taxes. The five federal income tax rates are 15, 28, 31, 36, and 39.6 percent.
Tax savings
Also known as a tax shield, tax savings is the amount saved by making tax-deductible investments. An example is a home purchase, because deducting mortgage interest generates savings by reducing taxable income.
Term
The duration of a loan. Auto loans are generally two to four years in duration, while home mortgage loans generally have 15- or 30-year terms.
Title
A legally-binding document that discloses ownership of an asset and any liens or other claims filed against the asset. A title should be examined for any recorded liens, which “encumber” a title and make its transfer more difficult than that of an unencumbered title. An unencumbered title is also referred to as a “clean” title.
Trade-in value
The amount a dealership will offer as consideration for an auto used as a down payment to purchase another auto.
Underwriting
A loan review process that begins with the acceptance of a loan application and ends with a decision to either approve or deny the loan request.
Upfront costs
These include any fees and charges collected in advance, before a loan is funded.
Upside-down
A situation in which the fair value of an auto is less than the principal balance of your auto loan. This often happens because of the large depreciation in the auto from excess due to excess wear and tear during the early years of an auto loan term.
Working condition fringe benefit
Any property or service provided to you by your employer for which you could deduct the cost as an employee business expense if you had paid for it.