So you want to get a car. You’ve identified the one you want, and can already picture yourself driving around the countryside with the windows down. But even the modest Toyota Corolla, one of Australia’s most popular cars, will set you back at least $20,000 brand new. Not exactly pocket change, so if you’re only saving around $5,000 a year, it could take around four years to save up that money. Of course, it might take you less than that if you earn more or have better savings habits, but you get the idea; cars are expensive, and it’s difficult to just have tens of thousands stashed under your mattress. This is where car loans come in.
Everything you need to know about car loans
A car loan is a type of loan you take out from a lender in order to purchase a car, ute or motorbike. To give you a quick summary of how a car loan works, you borrow money from a lender to buy a vehicle. Over a set period of time (the loan term), you will pay back this money to the lender plus interest. Car loans are a useful option to have, as you don’t need to have the full value of the car in cash in order to drive away in it. Let’s take a look at how this works:
Car Loan Example: Jake gets a new ute
Jake has always wanted a ute, and has his eyes on a Toyota Hilux, Australia’s most popular car model. He finds a new one available for $30,000 at his local dealership, and decides to speak to his lender about getting a car loan. He wants to buy the ute with $5,000 of his savings and a $25,000 car loan. After reviewing his reliability as a borrower, the lender agrees to provide Jake with a $25,000 car loan at an interest rate of 5.00% p.a, for a period of five years. His car loan repayments will be around $472 a month. There is also an upfront establishment fee of $400. Jake buys the ute and drives away with it. After the five years have passed and Jake has paid off the loan, he will have paid a total of $33,707 for the Hilux, which includes:
- $5,000 of his own savings
- $25,000 car loan
- $400 car loan establishment fee
- $3,307 in interest
He will have also paid thousands over the years in other car-ownership costs such as maintenance, fuel and insurance.
As you can see in this example, there are several key components of a car loan:
The interest rate
Since interest is the biggest cost of a car loan, the interest rate is the first thing you should look at. It is the rate you’re charged per annum on the outstanding loan balance. In the example above, the interest rate is 5.00% – quite a low rate in today’s market. You should always ensure that you know what the interest rate is on your loan, and compare the interest rates offered by a host of different lenders before making a final decision. There are two kinds of car loan interest rates:
- Fixed rates: fixed interest rates remain the same for the duration of the fixed term, regardless of market movements or changes made by the lender.
- Variable rates: variable rate car loans mean that your interest rate can change. This can be both good and bad: good if your lender drops the rates on the loan product, but bad if they increase it.
Another rate you’ll see is the comparison rate – more on that in the fees section.
The loan period
The loan period or term can be as short as one year or as long as seven years, at least among reputable mainstream lenders. A longer term means you’ll be paying off the loan for longer, but will make smaller repayments. This will cost you more in interest, however.
The most common repayment frequency is monthly, but ask your lender if they allow fortnightly or weekly repayments. Making more frequent repayments can help you pay the loan off sooner and with less interest, especially if the value of these regular repayments are at least half (fortnightly) or a quarter (weekly) of your monthly repayments.
Our example above only included one fee, but there are several others you could be charged that can significantly add to the cost of your loan. The fees to watch out for include:
- Upfront/establishment fee: the fee to take out the loan
- Ongoing fees: the maintenance fee charged on the loan
- Break fee: a penalty for when you pay off the loan in full before your term ends
- Discharge fee: a closing fee to cover closing the account
- Late payment fee: for when you fail to make a repayment on time
To help consumers get a better idea of a loan’s cost (interest rates and fees), lenders are legally obliged to display a comparison rate next to the advertised rates of their products. This comparison rate is calculated to include upfront and ongoing fees, so it will usually be higher than the advertised interest rate. A car loan that has a comparison rate that is much higher than its advertised interest rate is an indication that it has high fees relative to its interest rate.
Many car loan borrowers opt to have a balloon payment in the loan. This is an agreed upon lump sum (typically 30-50% of the borrowed sum) that is paid to the lender at the end of the loan term. Borrowers who want smaller regular repayments (monthly/fortnightly/weekly) can opt for a balloon, but over the life of the loan their total interest costs will be higher.
Obviously, you need to get the loan from somewhere, and much of the points above will influence your choice of lender. It’s vital that you do a thorough comparison of car loan products based on each of the above and how they might affect you. Certain lenders will offer products that offer much better value than others, so don’t just pick the one your neighbour Dave with the garage full of cars recommends.
To help you separate the good car loans and the bad car loans, this little summary should do the trick.
A low interest rate
A quick scan of the market at the time of writing (September 2018) for a variable rate new secured car loan shows you could get a rate of 5.34% (5.97% comparison rate) from one lender, which is pretty low. At the other end of the scale, another lender is offering a loan with an interest rate of 10.70% (10.90% comparison rate). If Jake (our ute-buyer from the earlier example) was to borrow $25,000 from either of these lenders, these would be his estimated interest costs:
|Advertised Interest rate||Monthly repayment||Total interest paid (over 5 years)|
|5.34% (5.97% comparison rate)||$475.68||$3,541.10|
|10.70% (10.90% comparison rate)||$539.83||$7,389.66|
As you can see, the car loan with the 10.70% interest rate could cost Jake almost $4,000 more in interest over the five years. So the lower the interest rate you can get, the better.
Little to no fees (low comparison rate)
But don’t focus too much on the advertised interest rate at the expense (pun intended) of looking at the fees. There are some lenders who advertise a low rate on the loan, and it very well might be, but they might make up for it with exorbitant fees instead. As we explained earlier, looking at the comparison rate can help prevent you from falling for such traps, because they factor in upfront and ongoing fees. But some incidental fees (such as the costs of refinancing or early payout fees) aren’t factored into the comparison rate, so it’s worth looking into these to prevent being caught off guard in the event you need to pay them.
Extra features that suit you
Some car loan features to consider in a car loan include:
- Pre-approval option (e.g. to help you negotiate with car dealers)
- Flexibility to switch between weekly, fortnightly and monthly repayments
- Balloon payment options
- Flexibility to make additional repayments
- Redraw facility
Don’t go for convenience over affordability, flexibility and practicality. If you just walk into any dealership and accept the first financing deal you’re offered, you’re more likely to be stuck with inflexible terms, a lack of ongoing support and higher interest rates and fees. Always compare other options before you sign up to anything and read as much as you can about car loans to check if you’re getting a good value deal.
Read more about the differences between dealer finance and car loans
To spot a scam car loan, ASIC recommends first checking if they’re on their list of unlicensed companies.
As much as it would simplify things, there isn’t just one generic type of car loans. There are multiple different types:
- Secured car loans
- Unsecured car loans
Which are further divided into:
- New car loans
- Used car loans
Secured vs unsecured car loans
Primarily, car loans are either secured or unsecured. Secured car loans involve you using the car you’ve purchased as a security on the loan, meaning that the car can be repossessed by the lender if you fail to meet the repayments. With this safety net, lenders often offer lower rates and fees on secured car loans. You may find it harder to get a secured car loan on a used car that’s over five years old. Unsecured car loans, as you might have guessed, do not use the car as a security, so they’re essentially a personal loan. This comes with the tradeoff of potentially higher rates and fees, and the possibility of legal action from your lender if you stop making your repayments.Read more about secured and unsecured car loans
New and used car loans
You can take out a car loan for both new cars and old cars, although certain loan products will only be available for one or the other. New cars are seen as less of a risk, because they can be resold for a higher amount. For this reason, new car loans often have a lower interest rate than used car loans, but since new cars are usually more expensive, you may need to borrow more to buy them. Different lenders have different criteria for how they define ‘new’ and ‘used’, although a common one in the industry is around five years or more for used cars.Read our guide to buying a used car
Not so fast there sport. You might be anxious to get into your hot new wheels, but before you even consider going to a dealer or lender, you’ll need to have a handful of forms and documents on you so they can get the measure of you as a person and as a borrower. Remember, it’s their money that you’re being lent, so your trustworthiness and strength of character will play a huge part in the terms you get given. When formally applying for a car loan, you’ll generally need:
- 100 points of ID (at least): can include your drivers’ license, passport, Medicare card and more
- The vehicle details: the make and model, registration number, engine number and purchase price, as well as whether it’s new or pre-owned
- Proof of income: you might need two or three recent payslips as well as proof of employment, employer contact information and two years worth of tax returns for those of you who are self-employed
- Assets and liabilities: details on any properties you own, any other loans you have, your ongoing expenses and any other debts, such as credit cards.
Once all of that nerd stuff is out of the way, you can dive in and apply for your car loan – assuming you’ve done some thorough research into which one is best for you. Thankfully, applying for a car loan in the modern age is quick and relatively painless, as there are a host of entirely online-lenders that can fast-track your application if you have all of this information handy. The usual process involves:
- You filling out an application form or filling in the blanks online
- Your application is reviewed by a credit officer
- The lender will then request your documents (possibly not all of them)
- Upon acceptance of the loan, you’ll be asked to sign it
- Your loan will then be funded, either directly to the person or dealer you’re buying the car from or in the form of a cheque
Bear in mind that those of you who are under 18 or not yet an Australian citizen may not qualify for a standard car loan product.
If you’re unsure about how to proceed with your car loan, you can always reach out to a car loan expert or financial advisor to get help finding a suitable product. There are hundreds of car loan products on the market, so it’s easy to feel overwhelmed by them all. Don’t let that happen! Keep your cool and remember what we said about comparing interest rates, fees and features.