Home Dollars & Sense How does car finance work? A complete guide to car loans

How does car finance work? A complete guide to car loans

By carbar on the May 12, 2023

9 minutes

It's no surprise that many Australians seek a car loan when buying a car. In fact, in March 2021, approximately 14% of Aussie's had a car...

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It's no surprise that many Australians seek a car loan when buying a car.

In fact, in March 2021, approximately 14% of Aussie's had a car loan, which is the equivalent of 2.7 million1 people!

Previously, around 19% of Australians2 had taken out a loan to purchase a car at some point in their lives.

So, considering how popular car loans are, it is important to find out more about the different types of financing available in the market before making a big decision.

Here is what you need to know.

What is a car loan?

A car loan is a form of personal loan taken out to buy a new or used car.

Car loans are popular because they allow consumers to purchase cars without having to pay for them in full upfront.

It requires you to repay the loan amount plus interest over a fixed term, which is usually between 1 and 7 years.

All lenders have lending criteria that must be met in order for a consumer to be eligible for the loan.

What types of car loans are available?

It is important to thoroughly compare car finance options before choosing a particular one for yourself.

There are typically two types of loans available to purchase a vehicle.

A secured loan or an unsecured loan.

Taking out a car loan is a big decision so before starting any loan application, it is important to ensure you understand the difference between both loans to determine which product is right for you.

Most car loans will be secured loans.

A secured loan is typically offered to an individual or business to directly purchase a car. It allows for immediate purchase and ownership. It is secured and supported by the purchase you are making, which means you must know what you are using the loan for. Because a secured loan entails offering collateral (generally, the car you are purchasing) to the lender, if you cannot make the repayments, the lender could potentially sell the asset to recover their costs. Because it is secured though, interest rates tend to be much lower making repayments more affordable in the long run.

An unsecured loan however requires no collateral. So there is no risk to your personal property and you generally have more control over your repayments. Because the risk of unsecured loans is higher, the lender may charge more interest for this type of loan.

Which is better?

Well, that all depends on your personal situation and your lending power.

Who offers car loans?

It will come as no surprise, but finding a lender in Australia should be relatively easy considering the

It will come as no surprise, but finding a lender in Australia should be relatively easy considering the saturation of lenders in the country.

It is a competitive industry out there and according to the RBA (as of December 2021), there are currently:

  • 96 Banks
  • 36 Credit unions and building societies; and
  • 102 Finance companies

And that doesn't include all of the brokers and financial advisors who are also able to assist in helping you find a car loan. As well as the non-bank lenders, which may be a consideration for some.

So, what are your options when it comes to choosing?

Because car loans are available from various financial institutions, it can be possible to get a loan in quite a few ways. It is worth checking out the options available and looking at all of them before making a decision.

Let's explore some of the most popular options for car buyers:

Car dealer finance

Whether you are in the market for a new or used vehicle, the showroom floor is quite often the place where you can see the cars in person and decide exactly what you are looking for.

Many car dealerships offer financing via their own lenders.

One possible benefit of dealership finance is its convenience which allows you to buy or finance your car simultaneously, allowing the dealer to handle all of the paperwork necessary to complete the loan.

However, if you have car dealers controlling most of the finances for you, it might be difficult to determine the best options for you and your circumstances. They could also potentially mark the price of the vehicle slightly higher in exchange for the service of obtaining the car loan for you.

Just like any financial decision, it's important to check out the contract details and any extra charges associated with it.

Secured car loans through financial institutions

For many, the most popular option for financing a car loan is through a bank, building society or credit union.

Most people already have a preferred bank that they use, so may find comfort in approaching them first.

Depending on the bank's offering, customers may be able to simply apply online or via telephone in some branches (if available).

An advantage of getting a car loan from a bank is the potential to negotiate the amount that will be repaid and the term of the loan depending on your requirements.

For some, it may be harder to go directly through a big bank, while others may find the lower interest rate a considerable advantage.

Redraw facility/line of credit

If you have a mortgage, you may be eligible to redraw. This means that you can withdraw from the extra r

If you have a mortgage, you may be eligible to redraw. This means that you can withdraw from the extra repayments you have already made to make another purchase, such as your new car.

This can offer two advantages:

  1. Home loan interest costs may be cheaper than car loan interest rates; and
  2. Combining two loan types can help make repayments simpler

However, some lenders may charge additional fees to redraw and also may have limits in place as to how much you are able to redraw.

Remember, every time you redraw, your home loan amount increases. So ensure you are well aware of the amount of time it could add to your loan or the increase in repayments you may need to allow for.

Peer-to-peer personal loans

An alternative option to obtaining a car loan from a bank or finance provider is a peer-to-peer loan, also known as a P2P loan.

P2P lending matches two types of people:

  1. People with money to lend; and
  2. People looking for a loan

Like any type of loan, it is important to understand how P2P lending works before making a final decision.

These non-bank lenders operate an online platform, which eliminates the middleman (your regular banker) and gives people the option to borrow directly from investors. It makes money by charging both parties.

Despite their cost and availability, they can carry upfront and monthly fees and can have shorter repayment terms and comparatively smaller borrowing amounts than conventional loan providers.

Borrowers can enjoy less interest but lenders may be hesitant due to the lack of security (unsecured loans) and the risk of the borrower failing to pay off the loan (there is currently no government protection available).

Setting a budget for your personal loan

When considering a loan, there are a lot of questions you will probably find yourself asking.

How much do I need to borrow?

How much should I borrow?

How much can I afford to repay each week/month/year?

You're not alone. And it is important that you ask yourself these questions before considering borrowing money.

To give you some insight into how much people borrow for cars, research by loan provider Plenti showed that the average car loan size in Australia is approximately $31,738.403

While this amount may be less than what you were expecting, it is important to note that of those people that took out a car loan, 70% of them were more likely to purchase a used car. This makes sense due to the current cost of new cars on the market and the average size of a car loan.

So setting a budget for a car loan will depend on whether you buy a new or used car, the type of car you are buying and how much you can afford to repay. A car loan calculator can help you figure out the maximum loan amount you could borrow and the possible monthly payments you would need to make.

What insurance policy should I buy for my car under finance?

If you're buying a car under finance, you will only have one option: comprehensive car insurance.

Comprehensive car insurance covers any damage to your car, as well as damage your car may cause to other property or vehicles in an insured event. It allows you to be covered for a wide range of damage caused by accidents, theft or weather events (such as hail, storms, fire or flood).

When choosing an insurance provider it is important to choose one that offers all of the benefits you may need, in the lifetime of your car. So look at their added extras like windscreen protection and roadside assistance, to name a few and decide if their policy is the best option for you.

Some banks or lenders may have a preferred insurance provider, which can potentially offer you a discount, however, it will be the most premium cover to ensure the lender is protected in every way possible.

While comprehensive insurance is not negotiable, you can negotiate the excess amount to make the monthly repayments more affordable. Of course, if you need to claim (and hopefully you won't), you may have to pay a higher lump sum to cover the excess.

Which factors affect your car loan repayments?

When taking out a car loan, one of the biggest factors is the amount you can afford to repay. If you have already decided on an amount for your car finance, then it is time to consider the factors that could affect your car loan repayments.

  • Loan size - If you want to go for a decent-sized loan, you will need to ensure that you have a good credit history and potentially no existing credit card debts. If you're not sure about your credit score, there are a few ways you can check your credit report. Your job and income stability will also play a major role in determining the amount you can borrow.
  • Interest rates - You may be looking at the purchase price, but it's also important to consider how the interest rate you are accepting will affect the amount you're actually borrowing over the term of the loan.
  • Loan period - Most loans offered have a period of 1-7 years, so depending on how long you choose to take the loan out for, will determine the amount of interest you will be charged over the term of the contract and the total amount of your repayments.
  • Fees and charges - Check your regular repayments for any ongoing fees or balloon payments that may be required throughout your loan term. You may also be faced with a late payment fee if you miss a payment or an early termination fee if you decide to pay off your loan early.

All car loan lenders will be available to provide you with all the information you need to find the best car loan for you.

How to apply for a car loan

Now that you understand how car loans work, you are one step closer to car ownership.

When buying a car, consider all of the finance options available to you and be sure to read the fine print, always.

Make sure you compare car loans and choose a personal loan that is right for you.

If you're not ready to finance a car, you could always consider a carbar car subscription. Not only will it be a little lighter on your bank account, but it will also allow you to experience all of the perks of car ownership without any of the major commitments.

Why not try before you buy?

1 https://www.finder.com.au/car-loan-statistics
2 https://www.finder.com.au/car-loan-statistics
3 https://www.finder.com.au/car-loan-statistics

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