Breaking down car loans – the basics
A loan is a financial product in which a lender provides funds for an asset. In return, the borrower pays back the loan with interest, usually over a set period of time (the term). Calculated per year or “per annum,” expressed as a percentage. You can find fixed rates over the loan term, or variable rates subject to market changes.
In this case, the car is the asset a borrower intends to purchase. There are three terms you should know before deciding on which type of loan is right for you – a secured car loan, an unsecured loan and comparison rate.
Secured car loan
A secured car loans means you are putting up your purchased car as collateral, or “security” for the loan. This offsets the risk a lender takes on in case you are unable to make repayments. In extreme cases, the lender is at liberty to repossess your security in the event of default. The advantage to this is that you may have a lower interest rate compared with unsecured car loans. Read our tips to get approved for your first car loan.
Unsecured car loan
An unsecured car loan does not require you to put your purchased car up as a security. As the lender takes on more risk, it is likely your interest rate will be significantly higher. These types of loans are less common than secured car loans, as your credit history will need to be exceptional. A lender may still take a defaulter to court to recover the property.
A comparison rate is an interest rate that includes most fees and charges that you will pay over the term of the loan. These are organised into comparison rate tables to show consumers the differences between similar products. Comparison rates do not include conditional fees such as early payment fees or statement fees.
Ask your prospective broker or lender for their comparison rate schedule. They are required to have one by law. This schedule or table shows you comparable loans at a glance.
Doing your homework
If you decide you need a car loan, you will have to do your homework. There are many lenders and brokers out there offering a range of different car loan products. It’s up to you to gather as much information as you can about what deals you can find and which suit you.
Difference between lender and broker
In the car loan market, you will come across two kinds of financial service providers – lenders and brokers.
Lenders are sources of capital, authorised to enter into a credit agreement with you directly. Lenders deal on a one-to-one basis. Lenders are typically banks, credit unions, car manufacturer financial services and stand-alone car loan specialists. Brokers are entities that have access to many lenders and financial institutions who find a car loan deal on your behalf. They sometimes may offer loans directly, but primarily look for the best deals on car loans and take care of the administration of the loan.
Checking up on lenders or brokers
Lenders and brokers at the very least should be licenced by the Australian Securities and Investments Commission as credit providers. If they don’t have an Australian Credit Licence, don’t deal with them. You can also check on them with online reviews and others who have used their services.
In principle approval
Before deciding on which car you will buy, many lenders and brokers will give you in principle approval. This gives you an understanding of how much you can spend on your car. It should be well within your budget. NOTE: do not consent to having your credit checked too often. Rejections, if they occur, may worsen your credit rating.
TIP: Dealers advertising “zero percent finance” are usually only offering cars on the lot “as-is” – without custom options or extras. They are often trying to shift product out the door to fulfil quotas or sales targets.
Bad credit car loans
People who have bad credit may find they can’t get car loans from mainstream lenders and brokers. Some of these lenders and brokers specialise in bad credit car loans. These loans come with much higher interest rates as the financial providers are taking on more risk. You should still shop around for these kinds of loans.
“Zero percent finance” and dealer finance
It may be tempting to apply for dealer finance, especially if they advertise “zero percent” finance or ultra-low comparison rates. The drawbacks to these are;
- dealers won’t negotiate on price to lower the cost
- extend the term beyond usual financial products, so the car is worth less than the loan or;
- slug you with lots of fees and charges to make more money.
Be wary of these deals and talk to a financial professional for more information.
TIP: When you are still in the shopping around phase for car loans, make sure your broker or lender is not performing a credit check. These appear on your credit history and could make finding other finance products harder in future.
If you are buying a car for 50% or more business use, you will have to sign a business purpose declaration. DO NOT sign this document if the car is for personal use. Business loans such as chattel mortgages do not fall under the same credit licencing restrictions as consumer loans. If in doubt, talk to a financial professional. Find out Chattel Mortgage’s GST and tax implications here.
Car lease vs. car loan
An option to get behind the wheel of a new car is leasing instead of buying. Leasing is like renting the car over a set period. At the end of the lease, your credit provider may sell the car to you – although you will need to come up with the money for purchase. If you want to own your car outright, taking out a loan and paying it off is the way to go.
TIP: Some car loans have what’s called a balloon payment or a residual value payment option. This reduces the amount paid over the repayment period, but you must come up with a lump sum payment at the end of the term. Talk to a financial professional about balloon payments.
Budget carefully for your car and your loan.
Car expenses only begin when you purchase your car. You have to budget for your car, which includes:
- Periodic (weekly, fortnightly or monthly) loan repayments
- Annual lump sum or periodic insurance payments
- Registration (annually)
- Scheduled servicing and repairs
When buying your car, you should find out how much insurance costs. You have an option to buy third-party insurance (which covers damage to others’ cars) or comprehensive car insurance (which covers damage to your own car.) If you are taking out a secured loan, comprehensive insurance is often compulsory. It also pays to shop around for insurance or find a good insurance broker.
TIP: Much like loan brokers, many insurance brokers find the best deal for you. They can also help you during times of distress as they may exert commercial pressure on insurance companies to fulfill their obligations..
Using loan calculators
Finding out how much a loan will cost is easier than ever before. You can use an online car loan calculator to figure out how much repayments will cost and the overall cost of the loan. MoneySmart has a multi-loan calculator to compare products side-by-side.
Add-ons and extras for car loans
Car loans may come with added extras that cost you more. Some are unnecessary but may fit your current situation. Here are some of the more common extras you’ll come across.
|GAP Cover/shortfall insurance||Will pay out the “gap” or shortfall between your outstanding car loan and payout from comprehensive car insurance if someone steals your car or it’s written off.||You may not need this coverage if you are buying a used car or have a good comprehensive insurance policy. Be sure to shop around.|
|Extended warranty||Covers the cost of unexpected repairs, parts and labour all within a set period of time.||New cars often come with warranties from the manufacturer, making this type of insurance unnecessary.|
|Loan protection insurance||Your insurance provider covers the costs of your repayments in the event of extended illness, injury or involuntary unemployment. Other types pay the loan off in the event of death.||This kind of insurance isn’t good value for money in many cases. Life or income protection insurance may cover the same eventualities for less.|
Be sure to look at the terms and conditions of your loan and insurance carefully at so you aren’t pressured into a hasty decision.
Repayments and hardship
You should always keep up with your loan repayments, as you may be charged penalty fees. Even if you can’t make full payment, pay as much as you are able. Defaults affect your credit history negatively. Hardship variations
If you are experiencing hardship, you should act as quickly as possible. You have the right to enact a hardship variation with your lender or broker. If they deny your request, you can complain to an independent dispute resolution body: either the Financial Ombudsman Service (fos.org.au) or Credit Ombudsman Service Ltd or by calling 1300 780 808.
You can also contact the Financial Counselling Hotline on 1800 007 007 or the ASIC Infoline 1300 300 630 for more information.