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What is an unsecured car loan?
An unsecured car loan is when a credit provider lends you an amount of money that is not secured by the value of an asset. As there is no collateral, if you default on your loan repayments, your lender cannot repossess the vehicle you have purchased with the loan.
Most car loans are secured, as this reduces the financial risk on the lender. If you default on your repayments, the lender can repossess the asset used as security. The asset used as security is typically the vehicle purchased.
Types of Unsecured Car Loans
Fixed Rate: As the name suggests, unsecured car loans with fixed rates charge the same interest rate during the entire loan term. That means that borrowers agree to pay a set amount of interest as part of their regular loan repayments, so repayments never change. This certainty can be appealing, but it could also mean borrowers miss out on rate cuts, because the rate stays the same regardless of whether the lender’s interest rate drop.
Variable Rate: Unsecured loans with variable interest rates means the interest rate on the loan may change during the loan’s term, so your repayments can change too. You can save money if there’s a rate cut, as your repayments will fall. However, if your lender raises the rate, your repayments would increase, and potentially leave you out of pocket if you have a strict budget.
Which is best, fixed or variable?
The best decision for you will depend entirely upon your financial situation.
If you have a strict budget, and you need to know exactly what your repayments will be, a fixed loan may be best. However, you need to be aware of the potential savings you could miss out on if interest rates fall.
If you opt for a variable rate loan, you will get the benefit of rate cuts. However, your loan repayments would rise with any rises in official interest rates. Given that scenario, it might be wise to work on the assumption that your interest rate will eventually rise by up to 3 percentage points, and budget accordingly. This means if your lender does increase the rate on your loan, you will still be able to make your repayments.
How to find the best unsecured car loan
As with all financial products, the best unsecured car loan will depend upon your own financial situation, including your spending and saving habits.
Is it better to get a secured or unsecured car loan?
The main benefit of a secured car loan is that interest rates can be lower. This is because the lender sees this type of loan as less risky, as the car itself or an asset of value is used as collateral. However, if something happens and you can't make your repayments, the lender can repossess the vehicle or asset used as security. This is the main downside.
Benefits of an unsecured car loan
Although borrowers may by charged a higher interest rate on an unsecured car loan, there are advantages to taking out a loan that does not require collateral as security.
Choose the amount you borrow: With an unsecured loan, you can borrow any amount you wish, as long as you prove that you can make the repayments. This amount could include the value of the car as well as other associated costs including insurance fees, registration costs and potentially repairs needed on the car if it is used.
No risk to your property: If you rely heavily upon your car for daily use and don’t want to run the risk of repossession if you cannot make your payments, an unsecured loan could be right for you. Even if you can’t make repayments, you would still have access to your car.
Lower interest rate than other credit: An unsecured loan will most likely charge a higher interest rate than a secured loan, but a lower rate than credit cards or short-term personal loans. If you’re deciding between an unsecured loan and a credit card or short-term personal loan, try creating a table to analyse and compare all fees, charges and rates, so you can make the best financial decision.
Disadvantages of an unsecured car loan
The main disadvantage of an unsecured car loan is that there is a higher financial risk to the lender, so they typically charge higher interest rates and possibly fees and charges.
Higher interest rate than secured loans: Unsecured loans will most often have high interest rates, due to the financial risk associated with giving a loan without security. Also, make sure to investigate all the fees and charges, as this is often where the lender makes money on the loan.
Strict rules on which borrowers qualify: The eligibility criteria is much stricter for unsecured loans than secured as there is no collateral on the loan. Borrowers must have a good credit rating, proof of income and expenses, and sometimes lenders will ask for a deposit to add to security.
Lenders can take legal action: If you do not make your repayments on an unsecured car loan, you will still have access to the vehicle, but could face legal action. Lenders and credit providers can turn your debt over to a collection agency, or file a civil lawsuit to recoup the money that’s owed to them.
Things to look out for with an unsecured loan
Before you decide that an unsecured loan is the best option for you to get behind the wheel of your dream car, there are a few things you need to consider.
Comparison rates: A car loan’s ‘comparison rate’ offers a simpler way to work out approximately how much an unsecured car loan can cost you. Expressed as a percentage, this figure combines the loan’s advertised interest rate with its standard fees and charges. This can then be used as the “interest rate” to calculate the total amount you will pay over the loan term.
Keep in mind that even a car loan’s comparison rate may not take its every cost into account – some non-standard charges and expenses could apply on the loan and not be included in this figure.
Fees for extra repayments: By making extra repayments and paying your car loan off early, you may think you’ll be saving money by reducing the total interest you pay over the lifetime of your loan. However, some lenders charge fees for making extra repayments or paying out a loan early. So, check whether these charges apply to the line you're considering. These fees tend to be more common with fixed rate car loans, though they are sometimes also found in variable rate car loans.
Loan to Value Ratio (LVR): If you don’t have a deposit for your unsecured car loan, you can borrow a greater percentage of your car’s value and smaller upfront deposit. Some unsecured car loans or online lenders will offer 100% of the loan amount, but keep in mind these types of loans are seen as even higher risk, and have much higher interest rates.
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How to choose between fixed and variable rate car loans
Before you buy a new set of wheels, it helps to explore your financing options and choose the right type of car loan to get the maximum value out of the deal. Unfortunately, there's no formula to decide which car loan is the best for you, but learning more about the available options can help you make an informed choice.
Personal Finance Editor
Alex is a personal finance writer and editor at RateCity, and has been writing about finance for over five years. She is passionate about closing the gender pay and superannuation gap, and aims to help young Aussies to overcome their financial apathy and better manage their finances. Alex has been published in numerous print and online outlets, including Money Magazine, Lifehacker Australia, and Business Insider.
Frequently asked questions
What is a secured car loan?
A secured car loan is a loan that is connected to a form of security, or collateral. Generally, the security for a car loan is the car itself. If you fail to repay the loan, the lender might seize your car, sell it and then use the proceeds to recover their debt.
What are loan repayments?
Loan repayments are the regular payments you make to pay off your car loan. Loan repayments generally occur on a monthly basis, although many lenders will also give you the option of making fortnightly or weekly loan repayments.
What are repayments?
Repayments are the regular payments you make to pay off your car loan. Repayments generally occur on a monthly basis, although many lenders will also give you the option of making fortnightly or weekly loan repayments.
What is the principal?
The principal is the value of the loan that is still outstanding. So if a borrower takes out a $20,000 loan, the principal is $20,000. If the borrower repays $5,000 in the first year, the principal is now $15,000.
What is an LVR?
The LVR, or loan-to-value ratio, is a percentage that expresses the amount of money owed on the car compared to the value of the car. For example, if you take out a $15,000 loan to buy a $20,000 car, you have an LVR of 75 per cent. LVRs change over time as you pay off your loan and your car depreciates in value. For example, two years later you might now owe $10,000 on your car, which might now be worth $15,000. In that case, although there would still be a $5,000 difference between the size of the outstanding loan and the value of the car, the LVR would now be 67 per cent.
What is salary packaging?
Salary packaging is an arrangement you can make with your employer that can allow you to buy a car from your pre-tax salary. The advantage of salary packaging is that it will redue your taxable income.
What is a balloon payment?
Some lenders will offer borrowers reduced monthly repayments in return for a one-off lump sum – or balloon payment – that the borrower has to pay at the end of the loan. Generally, the total repayments on a loan with a balloon structure will be higher than a loan without.
What is a refinance?
A refinance is when you swap one car loan with another. For example, you might take out a car loan with Lender X because it is the best on the market at the time – but two years later, you might switch to Lender Y because you discover that it now has the best loan. Conditions and fees often apply when you refinance.
What is a redraw facility?
A redraw facility allows you to re-borrow any funds you may have repaid ahead of schedule – although conditions and fees often apply. Not all car loans come with a redraw facility.
What is collateral?
Collateral, or security, is an asset you agree to surrender to a lender if you fail to repay a loan. Generally, the collateral for a car loan is the car itself. So if you fail to repay the loan, the lender might seize your car, sell it and then use the proceeds to recover their debt.
What is equity?
The equity is the share of the car that you own. For example, if you take out a $15,000 loan to buy a $20,000 car, you have $5,000 of equity in the vehicle, or 25 per cent. (The lender has the other 75 per cent.) Equity changes over time as you pay off your loan and your car depreciates in value. For example, two years later you might now owe $10,000 on your car, which might now be worth $15,000. In that case, you would still have $5,000 of equity in the vehicle, but your share would be 33 per cent.
What is repayment frequency?
Repayment frequency is how regularly you have to make car loan repayments to your lender. The most common repayment frequency is monthly, but many lenders will also give you the option of making fortnightly or weekly repayments.
Can you put a deposit on a car to hold it?
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.
Where can I get a student car loan?
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.
How to find a great car loan
Historically, finding a great car loan would require excess research ranging from visiting an excess of websites or making phone calls, but technology has moved on. Using RateCity, Australia’s leading financial comparison service, you can check out great deals from a range of lenders on the one site.
To start, select the amount you want to borrow and the length of the loan, narrowing your search to show just fixed or variable interest rate results.
Once you’ve indicated your search criteria, you’ll see an immediate list of lenders, ranked by interest rate or application fees. You’ll also be able to view the monthly repayment amount for each result, helping you to know what you can afford.
Up to six products can be compared side-by-side, complete with more information about each car loan, giving you more information about your options.
When comparing your car loan options, it’s ideal to keep in mind some points find a great car loan for your needs. Consider the following:
- Choosing a low interest car loan can reduce costs
- Selecting an option with low fees and charges is ideal, because these can really add up
- Be aware of penalties, such as early exit penalties if you pay off the loan sooner than expected
- Consider the features that best suit your situation
There are many ways to ensure that you get a great car loan. Ultimately, you’ll end up with the best deal by doing your research and selecting the most suitable product for you.
What is a guarantor car loan?
A guarantor car loan is a type of loan that features a guarantor on the agreement. The guarantor is a third-party individual, often a friend or relative, who guarantees the loan will be repaid if the borrower defaults on the car loan.
Guarantor car loans are often geared at people who might otherwise struggle being accepted for a secured car loan when purchasing a vehicle. Some of the reasons might include a lack of credit history such as with a student or young person, if there’s bad credit, or age as a factor such as with pensioners.
What is a guarantor on a car loan?
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.
Can I get a discounted student car loan?
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.
What is the role of a guarantor on a car loan?
The role of a guarantor on a car loan is to meet repayments if the borrower of the loan were to default for any reason, such as not being able to afford it.
Useful for loan applicants with poor or bad credit, a guarantor makes it possible for these loans to be made secure, because there’s less risk for a lender overall.
Companies will likely give fair warning before they charge a guarantor for the costs of the loan, or before they repossess anything of the guarantor’s that may have been used as security. Still, it is important for a car loan guarantor to fully understand their responsibilities before they commit to the transaction.