How Does A Car Loan Work?
Find out more about how car loans work and how a great finance deal can help you buy your next vehicle.
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Car loans are sought out by Australians all across the country when it comes time for them to start looking to buy their next car. They make paying for your car more manageable, enabling you to pay for vehicles at your own pace. Fortunately, you can read all about them right here with Savvy before submitting your quick quote. Once you’ve decided on what you need, we can help you drive away in your new set of wheels in as few as 48 hours.
The ins and outs of car loans
What are car loans and how do they work?
A car loan is a loan or credit product that individuals use to purchase a vehicle. A lender, after conducting responsible lending checks, will approve a customer for a loan if they sufficiently meet their eligibility criteria. This loan is either deposited to the customer’s bank account or transferred directly to their dealer or seller. In return for this money, the borrower must pay back the lender with interest.
The amount you borrow will be tied to the cost of purchasing your car, which must be manageable for you to repay on a monthly, fortnightly or weekly basis. You as a borrower can also decide the term over which you repay your loan, which ranges from one to seven years in length.
Additionally, the interest rate you’re offered on your loan will be dependent on several different personal variables, such as your job and income stability, credit score, history repaying similar loans and the type of car you purchase and its condition, as well as the Reserve Bank of Australia's cash rate. Car loans always come with fixed interest rates, making them better for budgeting into the future as you’re protected against rate rises across your term.
What types of car loans are available?
It's important to enter the car loan application process knowing exactly which product you need. As such, you should compare the different types of car loans thoroughly before settling on your finance type. These include:
Secured car loans
The most common type of car finance, a secured car loan is specifically granted to an individual or dealer directly to pay for a car and take ownership immediately. These are secured or backed by the asset being purchased. Since it is backed by a security, interest rates are usually significantly lower compared with unsecured car loans.
Chattel mortgage and hire purchase
Chattel mortgages are for business customers who use a car for business purposes 50% or more of the time. Like secured car loans, a business takes out a loan and pays the car off over time. Hire purchases are functionally the same, but car ownership rests with the bank or lender during the loan term instead.
Novated leasing
Novated leasing is an agreement between an employee, their employer and a car dealer. An employee sacrifices some of their salary to go toward a new car, which they take ownership of straight away. This has the effect of reducing their take-home pay which can reduce their tax obligations as they pay the car off.
Unsecured car loans
An unsecured car loan (or personal loan) is a loan product which enables the borrower to gain a lump sum of money to spend on a large purchase. There is no security or asset tied to the loan. As a result, these loans carry a higher than usual interest rate. You may seek out an unsecured personal loan if the car you're looking to purchase doesn't meet your lender's eligibility criteria, such as if it's more than 25 years old or in poor condition.
Which factors affect your car loan repayments?
Three major factors affect your car loan repayments: your loan amount, the term of your loan, and the interest rate.
Loan size
As an example, you wish to buy a $30,000 car and have been approved for a loan with a 5.5% p.a. comparison rate. You have $4,000 for a trade-in and want to pay off the loan in five years. In this situation, your loan would effectively end up becoming a $26,000 finance deal at 5.5% p.a., which would cost approximately $496.63 each month.
Let’s say you put up more money for the car – a $4,000 deposit as well as your trade-in, totalling $8,000. In this case, it becomes a $22,000 loan with monthly repayments of $420.23. This means you’d save over $75 per month and almost $600 overall.
Loan term
To demonstrate the difference a loan term makes to your repayments, you can compare the cost of the same $30,000 car loan at 5.5% p.a. (without a deposit) over four years instead of five. Over five years, you’d pay $573.03 each month and $4,382.09 in interest and fees. However, while a four-year term would increase your repayments by over $100 to $697.69, you’d only pay $3,489.32 in interest and fees overall, saving you almost $900.
Interest rate
Finally, even the smallest difference in interest rate can result in a meaningful saving. As mentioned, a $30,000, five-year loan at 5.5% p.a. would cost you around $4,382.09 over the life of the loan. Reducing that rate by just 0.5% to 5% p.a. would see you pay $3,968.22, a saving of over $400. Increasing your rate by 1% to 6.5% p.a., on the other hand, would cost you $5,219.07 over five years, resulting in a greater outlay of over $800.
Fortunately, you can use Savvy’s car loan repayment calculator as a tool to help you work out how much your loan will end up costing based on all of these different variables. It’s useful to use this before you commence your application to give you an idea of what different loans cost and whether they’ll be affordable for you.
What insurance policy will I need to purchase for my car under finance?
When it comes to purchasing a car under finance, there’s only one option available to you in terms of car insurance, which is comprehensive car insurance.
Comprehensive car insurance covers damage caused by you to both your car and those of other drivers, regardless of who is at fault, as well as damage caused by theft and weather such as fire, flood and storm damage. You can also purchase optional additional cover such as roadside assistance, personal effects cover (for valuable belongings damaged or stolen in your car) and the arrangement of a hire car following an accident or theft. You’ll be able to select your own insurer when purchasing your car with finance, so you can ensure you’re locking in a high-quality policy.
Additionally, in all states and territories of Australia, you will have to pay compulsory third party insurance (CTP) along with your registration. This might be included with registration or must be purchased from a third party. This covers you for accidents in which you inflict injuries on other people, which isn’t covered by comprehensive policies, but doesn’t cover any property damage.
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What to consider before taking out a car loan
Steer clear of “zero percent” or “1%” deals
Car dealers advertising “zero percent,” or “1%” finance can be misleading. These “deals” can mean you end up paying a higher price for the car overall. The terms may include high fees and short low-interest periods of six to 12 months before reverting to a standard or high interest rate afterwards.
Pre-approval can improve your negotiating power
When shopping around for a new car, having a strong hand can work in your favour. Getting a loan pre-approved with a set spending limit means you have a price ceiling. When negotiating with a dealer, if they cannot match your limit, you have no choice other than to walk away. This can prove useful during the end of sales cycles, when dealers are eager to liquidate stock and meet quotas.
Are you buying new or used?
A new car is more expensive than buying used; however, buying new could actually marginally improve the interest rate lenders offer you. New cars are more valuable and generally come with fewer risks, so lenders are more willing to lend to people who buy new. Weigh up which is more important to you before diving into the application process.
Deposits reduce your repayments
Having a deposit or trade-in when buying a new car can reduce your regular repayments substantially and improve your chances of lower interest rate approvals. With less of the purchase price of your car being payable with interest, the finance deal itself will be cheaper, and with more paid upfront, the lender is at a lower risk of losing out overall. Having equity in the car will lower your risk profile.
Know your credit history
Do you know your credit history? Find out where you stand before approaching brokers or lenders to understand your financial position. Having blemishes or defaults on your credit history may affect your ability to gain approval. Make sure you fix your credit history if it has any mistakes before applying. One of our experienced consultants will assess your application to help determine what the best available loan deal is based on your credit profile.
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