How do car loans work?

If you're in the market for a new car, a loan can mean a much wider range of new rides to choose from. Here's what to know about how car loans work and how you can get one.

How does a car loan work?

A car loan is a personal loan you use to buy a vehicle. Like any loan, you'll be required to make regular repayments (weekly, fortnightly or monthly), plus interest (fixed or variable), over the loan term (usually between one to seven years).

Car loans are generally secured against the vehicle itself, which means if you default on your repayments, the lender can repossess the car. Another quirk of car loans is they often include a lump sum 'balloon payment' at the end of the term. This reduces your repayments and the idea is if you decide to sell the vehicle at the end of the loan term, you can use the proceeds to pay off the loan. However, you still pay interest on the balloon amount, so you'll pay more in interest than you would without a balloon.

What makes a good car loan?

To help you separate the good car loans and the bad car loans, this little summary should do the trick.

A low interest rate

Car loan rates can vary depending on the age of the car and your creditworthiness, not to mention the cash rate. That said, there's a wide range of lenders that write car loans, so you might find some will offer you significantly lower rates than others.

Little to no fees (low comparison rate)

Some lenders advertise a low rate on the loan, but make up for it with exorbitant fees instead. 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 investigating 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

In the market for a new car? The table below features car loans with some of the lowest and variable interest rates on the market.

Important Information and Comparison Rate Warning

Learn to spot a bad car loan

Don't sacrifice affordability and flexibility for convenience. 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.

How to apply for car finance

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 borrowing, 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 licence, 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's 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:

1. You filling out an application form or filling in the blanks online

2. Your application is reviewed by a credit officer

3. The lender will then request your documents (possibly not all of them)

4. Upon acceptance of the loan, you'll be asked to sign it

5. 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.

Getting pre-approved for a car loan

Pre-approval on a car loan can be beneficial as it lets you know what you can afford before you go out to buy a car. To get pre-approval on a car loan:

1. Check your credit rating before applying

2. Compare car loan providers to make sure you've found the right one

3. Gather all of the necessary documents (100 points of ID, income, proof of employment, assets and liabilities etc.)

4. Contact your chosen lender and tell them you want to apply for pre-approval

Car loan guide

Below are some commonly asked questions about car loans, though you can learn more with our free car loan guide.

What are the different types of auto loans?

There are two main types of car loans: secured, which use the car as collateral for the lender, and unsecured, which do not. Another common type is known as 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.

What are low doc car loans?

Low doc car loans are 'low documentation' car loans, available to people who can't provide the usual documents needed to apply for one. They're commonly used by self-employed people who can't easily provide proof of income. Instead, a good credit history and proof of business ownership will often be enough. Low doc car loans may carry a higher interest rate than a standard car loan.

How long are car loans?

There are lots of different car loan terms available, but most reputable lenders will allow terms between one and seven years, with 10 years usually being the maximum. Your car loan term is how long it would take to pay off the car loan without any extra repayments.

How do I get a low-interest car loan?

There can be many ways to get a low-interest car loan, but one of the best ways could be to maintain a clean credit history. This tells lenders you're a trustworthy borrower, making them more likely to give you a good interest rate. Also, don't forget to shop around to see which lenders are offering the lowest rates. Secured car loans also tend to have a lower interest rate than unsecured loans.

How do I get a car loan if I'm a student?

Getting approved for a car loan as a student might be harder due to your lack of a credit history and lower income. But your chances of being approved for a student car loan can increase if you:

• Use a guarantor who can make the repayments if you can't

• Have a steady income

• Borrow less

• Buy a used car

Should I salary sacrifice my car loan?

Salary sacrificing for a car can be done through novated leasing, which can be a viable option for car buyers. Salary sacrificing is an agreement between you, your employer and the finance company where your employer agrees to let you take your car loan repayments straight out of your pre-tax salary.

Salary sacrificing for a car can generate significant tax savings for some (consider talking to a registered tax agent about this), but since you don't own a car (under a lease arrangement) there can be some limitations (e.g., driving restrictions, cannot make modifications etc.).

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