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Everything you need to know about car loans

So you’ve decided to buy yourself a car - congratulations! The next step for many Australians is finding car finance that suits their needs. Fortunately, RateCity compares a wide range of low interest and flexible car loans for a variety of borrowers. The next step on your car loan comparison journey is asking yourself the following questions:

What is a car loan?

A car loan is a loan that you can use only for purchasing a vehicle, such as a car, motorbike, van, truck or campervan. Car loans generally range from $5,000 to $100,000 and have loan terms lasting from one to 10 years.

When you take out a car loan, you not only have to repay the lump sum (or principal) you borrowed, you also have to pay interest (which is the price you pay to ‘buy’ the lump sum). This interest is a percentage of however much of your loan is still outstanding.

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How much can I borrow with a car loan?

If you already know what car you want, then you should only need to borrow the value of that car. You could possibly add a little more to your car loan to cover extra costs such as insurance, but the less you borrow, the smaller your monthly repayments, and the more money you will save in interest and fees.

The other option is to calculate the maximum car loan total you can afford to repay, then go car shopping with this budget in mind. But take care not to blow your entire budget on a more luxurious vehicle than you need. Choose a car with your head, not your heart, and you could ultimately enjoy a more affordable deal. 

How can I get the best car loan?

If you want the best car loan, you need to shop around. There are dozens of car loan lenders in Australia, so you can’t assume your current bank will offer the best value.

A comparison website like RateCity is a great way to research the market. You can use RateCity to sort loans through several filters, including:

  • Loan amount (e.g. $25,000)
  • Loan term (e.g. five years)
  • Loan type (secured v unsecured)
  • Interest rate (e.g. 7.49 per cent)
  • Interest rate type (fixed v variable)
  • Fees (upfront, ongoing, redraw activation, early exit)
  • Features (redraw, extra repayments, balloon payment)

By comparing and contrasting a wide range of options, you can find the best car loan for you.

What should I consider when buying a car?

  • Size – small, medium or large?
  • Transmission – automatic or manual?
  • Use – city or country?
  • Efficiency – how many kilometres per litre?
  • Appearance – does it suit my personality?
  • Space – how much leg room and storage capacity?
  • Safety – what will happen in a crash?
  • Technology – basic or advanced?
  • Performance – standard or superior?
  • Resale value – how hard will it be to resell?

How do car loans work?

Car loans work by creating a formal financing arrangement between three parties - the buyer (you), the vendor (usually a car dealership) and the lender.

There are four steps involved:

  1. The lender agrees to give you a loan to buy a specific vehicle
  2. You sign a purchase agreement with the vendor
  3. The lender pays the vendor on your behalf
  4. You repay the lender (usually over a period of several years)

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How do you compare car loans?

There are five main ways to compare car loans:

  1. Interest rate
  2. Fees
  3. Features
  4. Loan term
  5. Security

1. Interest rate

All things being equal, a loan with a lower interest rate is generally better than a loan with a higher interest rate.

That said, make sure you look at both the advertised rate and the comparison rate. The advertised rate will often be prominent. The comparison rate, though, will often be less visible - because it’s usually higher than the advertised rate.

The advertised rate is the interest rate you pay on the loan; the comparison rate combines the advertised rate and the main fees, so it generally provides a more accurate picture of the total cost of the car loan. That’s why some lenders make the comparison rate less prominent.

2. Fees

Ignore fees at your peril, because fees can significantly impact how much money you have to pay during the life of your loan. Fees may include:

  • Application fees (also known as upfront fees)
  • Account-keeping fees (also known as monthly fees or ongoing fees)
  • Early exit penalty fees
  • Redraw activation fees

3. Features

All things being equal, the more features a loan has the better, because these features can make it easier for you to manage your repayments and even save you money. Two common features are:

  • Extra repayments - this allows you to pay off your loan ahead of schedule
  • Redraw facility - this allows you to ‘borrow back’ extra repayments

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 and lower total repayments, while a longer loan term will mean lower monthly repayments and higher total repayments. Imagine you took out a $30,000 loan at an interest rate of 9.75 per cent - here’s how your repayments would look under three different loan terms:

Loan term Monthly repayments Total repayments
3 years $964 $34,722
5 years $634 $38,024
7 years $494 $41,510

5. Security

Some lenders will allow you to choose between a secured car loan (a loan in which you provide collateral, such as the vehicle you’re buying) and an unsecured car loan (no collateral). As a general rule, lenders charge higher interest rates for unsecured car loans, because they regard them as riskier than secured car loans.

Who can get a car loan?

It's easier to qualify for a car loan than a home loan, but that doesn't mean everyone gets approved.

To get a car loan, you will need to prove to the lender that you have the ability to repay the loan - which in turn means proving that you have a reliable source of income.

The best-case scenario is that you have a full-time job, a high income and an excellent credit rating. However, you may still be able to qualify for a car loan if you're a pensioner or if you have bad credit. In that scenario, though, you'll probably be charged a higher interest rate than a 'prime' borrower.

What is a normal interest rate on a car loan?

Unfortunately, there is no ‘normal’ interest rate on a car loan, because rates move up and down all the time in response to market conditions and competition. Generally, if the Reserve Bank of Australia (RBA) increases or decreases the official cash rate, car loan lenders will increase or decrease their own interest rates.

Car loan lenders also change their interest rates independent of the RBA. Sometimes, they might independently lower rates to entice more customers. At other times, they might independently increase rates to cash in on their existing customers – to earn more money from the same people.

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What is the best interest rate for a car loan?

Just as there’s no ‘normal’ interest rate on a car loan, there’s also no ‘best’ interest rate for a car loan. Why? There are two reasons:

  1. The best interest rate will differ from person to person, depending on their unique financial circumstances
  2. The car loan market changes all the time, so no one product can have the best rate forever

Lenders offer different interest rates depending on loan size, loan term, deposit size, security, car type and various other variables. So a lender might offer one interest rate for a $10,000 unsecured loan for a used car and a different rate for a $25,000 secured loan for a new car.

Another point worth mentioning is that your financial position will change from time to time. For example, the last time you bought a car, you might have needed that first ($10,000 unsecured) loan, whereas this time you might need the second loan. So what was best for you might not be best for you now.

Furthermore, lenders often change their car loan interest rates – sometimes due to market forces and sometimes due to the pressures of competition. What that means is that whatever product offers the best interest rate today might not offer the best interest rate tomorrow.

What are the different types of car loan?

There are seven different types of car loan:

  1. Unsecured car loan - a loan for which you don’t provide collateral.
  2. Secured car loan - a loan for which you provide collateral (often the car you’re buying).
  3. Chattel mortgage - a secured car loan in which you use the car you’re buying as collateral
  4. Operating lease - like a long-term car rental arrangement. It involves a company leasing a car for an extended period.
  5. Commercial hire purchase - like a rent-to-buy arrangement. It involves a finance company buying a car on your behalf and letting you use it in return for regular rental payments. After a certain number of payments, you officially own the car. (A commercial hire purchase is also known as a CHP.)
  6. Car lease - like a CHP, but with more options. You rent the vehicle for a set period, during which you make regular rental payments. At the end of the lease, you either return the car or buy it. (A car lease is also known as a finance lease or asset lease.)
  7. Novated lease - like a car lease, but with a more complicated ownership structure. You loan a car from a second party (usually an employer), which in turn leases it from a third party (a finance company).

How do you get the lowest interest rate?

There are two things you need to do if you want the lowest interest rate:

  1. Shop around
  2. Make yourself a less risky borrower

1. Shop around

There are dozens of different banks, credit unions, building societies and non-bank lenders that offer car loans in Australia.

Given how big and competitive the market is, you need to do your research if you want to find the car loan with the lowest rate.

2. Make yourself a less risky borrower

Lenders often give lower interest rates to borrowers they regard as less risky. Here are seven things that might make you less risky in the eyes of some lenders:

  1. Having a higher credit score rather than a lower credit score
  2. Taking out a secured loan rather than an unsecured loan
  3. Providing a higher deposit rather than a lower deposit
  4. Having a full-time job rather than a casual job
  5. Having a steady income rather than a fluctuating income
  6. Having lower expenses rather than higher expenses
  7. Having a higher savings rate rather than a lower savings rate

One final point: the car loan with the lowest interest rate may not be the best car loan for your specific circumstances.

Is the cheapest car loan always the best?

The cheapest car loan isn’t always the best, for two reasons:

  1. A cheaper loan might actually cost you more in the long run than a dearer loan
  2. A cheaper loan might offer less flexibility than a dearer loan

1. A cheaper loan might actually be dearer

Sometimes, the reason lenders can afford to charge such low interest rates is because they make back their money on fees. Imagine you were comparing two $30,000 five-year car loans - in the hypothetical example below, the loan with the higher interest rate actually costs less over the life of the loan than the loan with the lower interest rates.

Interest rate Application fee Monthly fee Total repayments
5.50% $500 $15 $35,782
6.50% $100 $0 $35,319

2. A cheaper loan might be an inflexible loan

Do you want a redraw facility? Do you want to be able to make extra repayments? Do you want to reduce your interest costs by paying off your loan ahead of schedule?

Some car loans offer these options. But other loans - including some low-rate loans - aren’t as flexible.

That’s why the cheapest car loan might not suit your circumstances as well as a loan with a higher interest rate.

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How should I handle my car loan repayments?

When comparing car loans, try to get an approximate idea of how much you can afford to pay back each month. You can then use this figure to help you determine which car loans may be the best for you.

Remember that if you opt for a car loan with a variable interest rate, your repayments could go up or down from month to month, so if you’re planning your budget in advance, it’s worth leaving a bit of wiggle room just in case of surprise increases to car loan rates.

If you’d rather not risk being left out of pocket by car finance rate rises, you might consider a fixed-rate car loan, where the interest rate stays the same for the lifetime of the loan. While you won’t enjoy savings from interest rate cuts, at least you’ll enjoy the security of knowing exactly how much you’ll be paying per month.

If you want to lower your monthly repayments, you could opt for a longer loan with smaller instalments. Just keep in mind that if you choose a longer car loan term, you’ll ultimately pay more in interest over the lifetime of the loan, costing you more in total than if you’d made larger monthly repayments over a shorter period.

It’s also worth remembering that for many car loans, you won’t just be paying interest, but additional fees and charges as well, such as application fees and ongoing fees. To get a better idea of which car loans are likely to cost you more in total, check out their ‘comparison rates’.

Comparison rates combine the advertised car loan interest rates with their standard fees and charges, and express them as a percentage. Remember that a car loan’s comparison rate might not include its every cost or account for its extra features, so use the comparison rate a guideline and not as a decision-maker. 

How do I take out a car loan?

  1. Calculate how much you can afford to repay each month
  2. Calculate how much you can borrow
  3. Decide what car you want
  4. Choose between a new car and a used car
  5. Calculate how much of a deposit you will need
  6. Choose between a shorter loan term and a longer loan term
  7. Choose between weekly, fortnightly and monthly repayments
  8. Choose between a secured car loan and an unsecured car loan
  9. Choose between a variable-rate loan and a fixed-rate loan
  10. Decide whether to get the car loan through a comparison site, finance broker, car dealer or direct-to-lender  

Secured vs unsecured car loans

Many car loans are 'secured', which means that if you can’t make your repayments, the lender can recover its losses by repossessing an asset of yours – usually the car you’re buying. These loans often have lower interest rates, as they represent less risk to the lender, though some lenders only offer secured loans for cars that fit certain criteria.

If the vehicle you’re looking at isn’t eligible for a secured loan, some lenders offer ‘unsecured’ car loans, where your shiny new (or used) vehicle is not at risk of being repossessed, but you may have to pay higher car loan rates instead.

Car loans for new cars vs old cars

While you may need to pay more up front for a brand new car, lenders tend to consider new cars to be less of a financial risk than used cars, because they’re of a higher quality and enjoy a higher resale value. So you may enjoy a more competitive interest rate on a car loan for a new car.

Conversely, a car loan for a used car might attract a higher interest rate, because the loan is seen as a greater risk. That said, used cars are often cheaper than new cars and tend to depreciate at a slower rate, balancing the scales somewhat when it comes to car financing.

Different lenders use different criteria to definite ‘new’ and ‘used’. Some may use two years as a benchmark – any younger is new and any older is used. Some lenders also have a maximum age for vehicles they’ll offer loans for (e.g. five years), as vehicles older than this are considered too high-risk.

How does the car loan approval process work?

There are five steps in getting a car loan approved:

  1. Application - You apply for the loan, either through a broker or directly with the lender. Either way, you will probably be asked to provide documents to prove your identity, income, employment, savings, assets and liabilities.
  2. Assessment - The lender checks your paperwork to make sure you are who you say you are and that you have the capacity to repay the loan.
  3. Decision - The lender either approves or rejects your application.
  4. Signing - If your application is accepted, you will be asked to sign a loan contract that sets out your loan amount and loan term.
  5. Payout - The lender pays out the money. The money will either be sent directly to the vendor or will be transferred to your account so you can pay the vendor. 

Can I pay off my car loan early?

If you find yourself with some extra money available, you might be able to add that extra cash onto your car loan. By making higher or additional repayments, you can get closer to exiting your car loan early, and reduce the total amount of interest you need to pay.

Just remember that some lenders charge fees for making additional payments and/or making an early exit from your loan, to make up for some of the lost interest. These fees and charges tend to be more common for fixed-rate car loans where your repayments are scheduled well in advance, but always check first before taking out a car loan.

A ‘redraw facility’ is another handy feature to keep an eye out for if you’re thinking of adding extra money onto your car loan. If you find yourself in a tight financial spot, a redraw facility will allow you to reclaim any extra money you’ve paid onto your car loan, freeing up your car financing to cover unexpected expenses.

This extra flexibility can allow you to pay extra towards your car loan with confidence, as you’ll be able to access these funds again if you really need them. Just check your lender’s terms and conditions, in case there are restrictions on how the redraw facility can be used.

Do I need a deposit for a car loan?

If you have your eye on a particular car but don’t have enough money for a full deposit, it doesn’t mean that vehicle is out of reach. Some lenders offer car loans with a high loan-to-value ratio (LVR), where you pay a smaller deposit and borrow a greater percentage of the car’s value.

Some lenders also offer 100 per cent car loans, where you pay no deposit and instead borrow the full value of the car. These offers typically involve higher interest rates due to the increased risk to the lender, so check whether you can afford the repayments to determine if a 100 per cent car loan is right for you.

What should I look for when comparing car loans?

When making a car loan comparison, the best car loan for you is one that not only has the features you want, but is also one you can afford. So do your sums with loan sizes and interest rates before signing on the dotted line.

By comparing the car loan offers at RateCity, you should soon be able to narrow down your car financing options to just the car loans offering the terms that best suit your needs. That way, you can be confident that the loan you take out is just as good as the car you buy.

Australia's most popular cars

The top brands by number of registrations are...

  1. Toyota (2.9 million)
  2. Holden (1.8 million)
  3. Ford (1.2 million)
  4. Mazda (1.2 million)
  5. Hyundai (1.1 million)
  6. Mitsubishi (835,000)
  7. Nissan (820,000)
  8. Honda (713,000)
  9. Subaru (658,000)
  10. Volkswagen (479,000)

Source: ABS Motor Vehicle Census 2018

There are four different ways you can get a car loan. You can go straight to a lender. You can get a finance broker to organise a car loan for you. You can get ‘dealer finance’ – which is when the car dealer organises a car loan for you. Or you can organise your own car loan through a comparison website, like RateCity.

Whichever method you choose, you will need to provide proof of identification, proof of income and proof of savings. So you may be asked for any combination of passport, driver’s licence, bank statements, payslips, tax returns and utility bills. You might also be asked to provide proof of insurance.

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