What is a car loan?
A car loan is a loan used by the borrower to buy a new or used motor vehicle. Car loans typically range from $5,000 to $100,000 and often have loan terms from one to ten years. Interest rates vary between 5% and 10% for secured car loans, and up to 15% for unsecured loans.
When you take out a car loan, you need to repay the lump sum you borrowed (the "principal"), as well as interest on the car loan. The interest rate will apply on the loan amount from the time that you take out the loan. Car loans tend to share things with personal loans, and that's because a car loan is a type of personal loan, though the interest rate on a car loan can be lower than on a personal loan as the loan is often secured by the car you are purchasing.
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How do car loans work?
A car loan is a formal car finance arrangement between three parties: the buyer (you), the vendor (someone selling the car, typically a car dealership), and the lender (the organisation providing the money). You can get a car loan to buy a new or used car.
There are four steps involved in getting a car loan:
- The lender agrees to give you a loan for a certain amount to buy a vehicle
- You sign a purchase agreement with the vendor
- The lender pays the vendor on your behalf
- You repay the lender, usually over a period of several years
Finding the best car loan for your needs is a key part of the process. Everyone's financial situation is different, so there's no one "best car loan" to cover every possible need. To help you find your best car funding option, a comparison of car loans is critical to ensure your loan fits your particular needs.
So where do you start? Once you know what sort of car you would like to buy, you’ll need to consider how much you can borrow and then compare car loans.
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How much can I borrow with a car loan?
How much you can borrow, or your borrowing capacity, depends on your income, your expenses, your assets and any other debts that you may hold. Your credit history too is relevant and is used by lenders to determine your creditworthiness. If you have previously defaulted on loan repayments or have often been late in making repayments, a lender may reduce the amount they are willing to lend to you, or even refuse you a loan.
For a secured car loan, the amount you can borrow will also depend on the cost or value of the car. You may not receive as much from a lender to buy a used car as you would to buy a new car.
Once you have an idea of what you’d like to borrow, you can use a car loan calculator to find out how much your repayments will be.
How do you compare car loans?
To compare car loans, make sure you are comparing apples with apples: secured car loans must be compared with secured loans, and unsecured loans with unsecured loans. You will need to consider the interest rates, any applicable fees and other loan features. You should also consider the lender’s reputation and how good their service is. If the lender’s reputation is bad, the chances are the service could be bad too. Factor all of this in to your car loan comparison and you'll be able to work out which car loan best suits your needs.
1. Interest rates
Comparing interest rates is an important first step in comparing loans. There are two parts to a loan’s interest rate: the advertised rate and the comparison rate. The advertised rate is just the interest rate you pay on the loan, while the comparison rate combines the advertised rate and the main fees, including upfront and ongoing fees. The advertised rate will often be shown more prominently, while the comparison rate will be less visible because it's usually higher than the advertised rate.Be sure to look at both rates when making car loan comparisons.
Car loan fees can significantly impact how much money you have to pay out during the life of your loan. Fees typically include the following:
- Application fees, also known as upfront fees
- Account-keeping fees, such as monthly fees or ongoing fees
- Early exit fees
- Redraw fees
Different lenders will charge different fees to boost their bottom line, so make sure you ask about all of them.
Tip: Need more information on how to get the best car loan for your needs? Check the car loan guide right now.
Car loans, like home loans, can vary dramatically in what they offer. Some will have a variable interest rate, where the rate can change during the loan’s term, while others may be fixed for the life of the loan. Some loans will allow extra repayments or early repayment, while others will not. So make sure you ask about all of a loan’s features, as they can affect how much you will need to pay over the life of your loan.
A car loan which allows extra repayments, for example, enables you to pay off your loan ahead of schedule and to minimise interest costs. A loan with a redraw facility allows you to “borrow back” extra repayments so you can access cash if you need it down the track, without having to apply for another loan. Such flexibility can save you time and money in the future.
4. Loan term
Some lenders are very flexible in how much time they’ll give you to pay off the loan, while others will limit your options. As a general rule, a shorter loan term will mean higher monthly repayments but a lower total loan repayment, while a longer loan term will mean lower monthly repayments but a higher total loan repayment, as you will be paying back more in interest costs. Ultimately, you need a car loan that you can repay comfortably, over a period of time that suits your needs.
5. Loan type
Some lenders will allow you to choose between a secured car loan, that is, a loan in which you provide collateral, such as the vehicle you’re buying, and an unsecured car loan, where no collateral is provided. Lenders will charge higher interest rates for unsecured car loans because they regard them as riskier than secured car loans.
6. The lender
You probably already bank with one of Australia's big four: ANZ, Commonwealth Bank, NAB or Westpac. While they're big, they may not offer the best loan for your needs. Shop around and you may find a more competitive car loan from a smaller bank or a non-bank lender.
Who can get a car loan?
To qualify for a car loan, you'll need to show a lender that you have a regular source of income so you can afford to make regular repayments. Lenders will want to know if you are employed and how long you have been with an employer. If you’re self-employed, a lender may require you to show two years’ trading history in order to qualify for a car loan.
The best-case scenario is that you have regular income and an excellent credit rating. You may still be able to qualify for a car loan if you're a student or a pensioner, though you may pay a higher interest rate than someone who is employed full-time.
Knowing your credit rating and credit history will give you a glimpse into what you can expect from car loan rates. If you have a bad credit history, there's still hope, but you just might be looking at bad credit car loans, where the rates may not be as competitive as you would wish.
Car loan benefits and disadvantages
What are the benefits of a car loan?
Using a car loan to help you buy a car today comes with many benefits, including:
- You can use a car loan to borrow more money, opening up options for vehicles that you couldn’t otherwise buy
- You don't have to repay a car loan immediately and can take as long as ten years to repay the loan
- The car loan’s interest rate may be much lower than that of other finance options, such as an unsecured personal card
What are the disadvantages of a car loan?
There can be some negatives to getting a car loan, which you will need to consider and weigh up against the benefits. These include:
- Repayments need to be made regularly. If you stop repaying, you may lose the car, and potentially face other penalties, such as legal costs
- Your car loan may have restrictions on the type of car you can buy, such as whether it is new or used or a sports car
- The amount you can borrow may be limited by your borrowing capacity and creditworthiness
How many types of car loans are there?
Generally speaking, there are seven different types of car loan:
- Unsecured Car Loans: car finance where you don’t provide collateral
- Secured Car Loans: car finance where you do provide collateral
- Chattel Mortgage: a secured car loan in which the lender automatically uses the car you're buying as collateral
- Operating Lease: more like a long-term car rental arrangement, involving a company leasing a car for an extended period
- Commercial Hire Purchase: closer to a rent-to-buy arrangement, generally involving a finance company buying a car on your behalf and letting you use it in return for regular rental payments. After a number of payments, you may own the car
- Car Lease: similar to a commercial hire purchase, but with more options. You rent the vehicle for a set period and at the end of the lease, you either return the car or buy it
- Novated Lease: like a car lease, but with a more complicated ownership structure, as you acquire the car from a second party (usually an employer) which in turn leases it from a third party (a finance company)
What is the best car loan?
The best car loan is a car loan that meets all your needs, taking into account price, features and benefits. Shopping around and making car loan comparisons is a key part of the process. There are dozens of car loan providers in Australia, and you shouldn't assume your current bank will offer you the lowest interest rate or the best deal. Comparison websites like RateCity offer a great way to compare car loans, including costs and features. Using a comparison site can also cut down the time you take to research car loans considerably.
Car loans pros and cons
Should I get a car loan through a dealer? Discover the pros and cons of dealer car loans.
You don’t need good credit to get a car loan, although the worse your credit history, the harder and more expensive it’s likely to be.
Some lenders will do business only with borrowers who have good credit. However, there are other lenders that are willing to offer car loans to borrowers who don’t have good credit. The catch, though, is that they may charge higher interest rates and fees, and also require more paperwork.
If you don’t have good credit and want a car loan immediately, you can search for lenders that work with bad credit borrowers. If you are able to wait, you can work to improve your credit score and then apply for a car loan once you have good credit.
You may be able to get a no credit check car loan in certain circumstances, although it’s important to weigh up your options before doing so.
Most lenders refuse to provide no credit check car loans, because they don’t want to give loans to borrowers without first confirming that they have a track record of repaying debts. So any lenders that do provide no credit check car loans would take measures to protect themselves against the risk of default.
That’s why no credit check car loans have higher interest rates than other car loans. Also, borrowers often have to provide security and put down a larger deposit.
You might be better off finding a specialist lender who will look at your credit history and income, who will decide whether or not you are able to responsibility pay back the loan. Alternatively, you could contact a car finance broker.
Being a student is tough enough, and while you might find the odd student discount on movies and technology, the same can’t be said about car loans, as you can’t really get a discounted student car loan.
Lenders make money on the interest and fees that they charge with loans, and the lowest interest and fees are given to the most reliable credit holders: people with excellent credit history.
As a student, you are unlikely to have enough on your credit report to warrant an excellent history. There are however, ways of getting a lower interest car loan if you can’t get an interest-free loan from the bank of mum and dad. One way of doing this may be through getting a guarantor car loan, which can get you a secured car loan by setting your parents up as guarantors.
Poor credit doesn’t necessarily mean you won’t be able to get finance for your car purchase, though your options aren’t likely to be the same as someone with good credit.
In fact, a number of specialist lenders exist offering car finance for customers with poor credit, able to provide access to bad credit car loans.
However having a history of poor credit will likely mark you as a potential risk to lenders, so your car financing needs could see higher fees and interest rates. Alternatively, consider a secured car loan, which is a type of loan that uses the car you purchase as collateral, reducing the risk.
Other options include getting someone close to act as a guarantor for your car loan, or to talk to a broker about a personalised rate specific to your circumstances.
A guarantor on a car loan is a third party, usually a relative or friend, who guarantees to meet the repayments of a loan for the purchase of a car, if the borrower/owner of the car defaults on the loan.
Guarantor car loans can be useful for people who would otherwise struggle in being accepted for credit to purchase a vehicle. These may include people with bad credit, students and young people who may have no credit history, as well as some pensioners.
Many lenders offer guarantor car loans, guarantor personal loans and guarantor home loans, because of the significantly reduced risk to the lender.
Yes, you can get a car loan with bad credit, although you’ll probably find the process trickier and dearer than that experienced by people who have good credit histories.
You can find a number of lenders that specialise in bad credit car loans. However, make sure you compare bad credit car loans before you sign on the dotted line, because not all car loans are alike and having bad credit may mean you are more likely to be hit with higher fees and interest rates.
If you have bad credit, it’s important not to take out a car loan unless you can afford the repayments because a default could further damage your credit rating. Conversely, if you make all the repayments and repay the loan successfully, your credit rating might improve.
While it’s not necessarily a guarantee, having a guarantor on your car loan will improve your chances of having your application accepted, and may mean that you are able to attain a lower interest rate loan.
Having a guarantor with excellent credit history and/or is a property owner reduces the risk to the lender because the payments are guaranteed by someone who is considered to be financially secure and reliable.
As such, even if your credit history isn’t perfect, a guarantor may be able to help you secure a lower rate from some lenders.
Student car loans are not a necessarily a product in and of themselves, but what you may be looking for is a guarantor car loan.
A guarantor car loan has a third-party act as a form of guarantee for your loan application, telling the bank or lender that if you default on your loan, someone will pay the loan repayments.
Going guarantor on a car loan is no new thing, and before internet-based credit scores, guarantor car loan applicants would apply for loans with a guarantor or property owner who could vouch for the person borrowing the loan.
To get a guarantor car loan, you’ll need someone willing to act as a guarantor for your car loan.
It’s up to individual car dealers to decide whether to promise to hold on to cars in exchange for deposits.
Some car dealers will request a deposit and promise, in return, to hold on to the car for a certain period of time. Others will request a deposit but make no guarantees, other than to return the deposit if they end up selling the car to someone else.
Some car dealers ask for deposits; others don’t. If you get asked for a deposit and you decide to pay it, make sure the dealer gives you signed paperwork before you make the payment and a receipt after you’ve made the payment.