Whether you are in the market for your first car, an upgrade to accommodate a growing family, or a flashy new set of wheels, one option to help you achieve your new car dreams is with a car loan.
What is a car loan?
A car loan is a personal loan that's used specifically to buy a vehicle, whether it be new or used. Being a personal loan, car loans are structured to allow borrowers to be granted a principal sum of money with repayments made back to the lender over time. Car loans also involve interest, which is required to be paid back to the lender alongside the principal amount.
Failure to meet principal and interest repayments can potentially result in the lender repossessing the car - however this depends on the car loan type, such as if it's secured or unsecured.
What to consider with car loans
Secured vs unsecured
There are two main types of car loans: secured, which use the car as collateral for the lender, and unsecured, which do not.
Secured car loans are structured in such a manner that the car you intend to purchase is used as collateral against the loan. This means that in the event that you fail to meet your repayments, the lender has the right for repossession.
Unsecured car loans are the direct opposite, meaning they not require you to use your car as security. As a result this presents a greater risk to the lender, which as a result will generally be at the hands of a higher interest rate.
New vs used
A new car loan is a type of personal loan that allows you to finance a brand new or demo vehicle. With many lenders, for it to qualify as new, the odometer reading must be low, say under 100km or in the case of a demo under 1,000km.
There are also car loans for used cars. Lenders usually have different rates for newer models, say up to 5-7 years, while there is another subset of rates for older models, say 7-12 years.
Lenders will generally look to minimise or avoid risk by placing an age cap on used cars that are eligible for a used car loan. This is to ensure the used car will outlive the length of the loan. This might apply from the age of the car at the start of the loan, or the maximum age of the vehicle at the end - each lender is different.
Another common option is known as a car loan with balloon payment. A balloon payment or 'residual value' is an agreed-upon lump sum that you will pay to your lender at the end of the car loan term.
A balloon payment, sometimes up to 30-50% with some lenders, can help lower your repayments dramatically. However, you won't want to forget about it, because if you had a $50,000 loan on a 30% balloon, you would owe up to $15,000 at the end.
A common option at the end of the balloon is to trade in the car, recoup the balloon value that way, and then hop into a new car with a new car loan. This could be preferable for those who like to change cars every three to five years. However, for those looking for a longer-term option, a balloon might be a hit to the budget you don't need.
How to apply for a car loan
Car loans are quite straightforward in their application process, sharing similarities with other personal loans. You will be required to provide the lender with details of the car you're looking to buy, as well as all your personal and financial information. This includes your income, assets, existing debts and so on so that the lender can assess your ability to make necessary loan repayments.
It's also a good idea to determine your credit rating before proceeding with car loan applications. If your rating excellent, you'll likely be eligible to receive some of the lowest car loan rates on the market. If your rating isn't up to scratch, then maybe take some time to improve it or accept that you may not get the best car loan rate out there.
Have all your information on hand
If you're going through a lending body rather than your own bank, you may need to provide the contact details of people who can verify the information on your application. These people include your employer, your landlord or mortgage provider, as well as previous credit providers and an accountant. Your lender may contact them to make sure your information is accurate and that you're a reliable borrower.
You can put the pedal to the metal on your new set of wheels by being granted pre-approval from your car loan lender. This means if you know you have a set principal amount pre-approved for you because your bank is satisfied you meet lending criteria, then you have a much stronger negotiating position when you approach dealers.
Visiting showrooms, taking a shine to a particular car and then having to go through the applications mill, negotiating a few dollars down here and there and then applying for the loan is stressful. You might also find that dealers are prepared to compromise on the price if your finance is guaranteed. Don't dawdle, though, as your pre-approval might only last for a month.
What interest rates can you expect with a car loan?
While the interest rates on car loans are lower than many credit cards, they can still vary depending on a number of internal and external lending factors. These can include your overall credit rating, deposit amount, length of the loan and the cash rate.
Typically most car loans range from a period of between three to seven years, with the greater the length of the loan, the more amount to be paid in interest. InfoChoice offers the ability to compare interest rates and comparison rates across a broad range of car loan options to determine the products that may best suit your financial position.
Making additional payments
Although you'll initially agree to a set term for the loan, you may have the option to additional payments to pay the loan off faster. This can prove to be a significant benefit to your finances as each dollar you remove from the balance stops accruing interest. This means not only do you pay the loan off quicker, you also pay less interest - ideally the best of both worlds.
While this may be beneficial to you, to the lender it is not. As a result finance providers may require you to pay an early exit fee if the loan is paid off earlier than anticipated.
It's essential to use a car loan calculator right from the start so you can find the deal that results in the easiest monthly repayments for you.
What you need to ask your lender
If you're looking for a car loan, there are some important things you need to find out from your lender before you proceed. These include:
- What the interest rate will be and the steps necessary to qualify for a lower rate?
- Are there are any application fees or ongoing fees?
- Does the lender offer car loan pre-approval? If so, how long does it last?
- Are extra repayments able to be made? Is there an early exit fee for paying off the loan early?
- How can I check my loan balance?