How Does A Car Loan Work?

Find out more about how car loans work and how a great finance deal can help you buy your next vehicle.

No obligation. It won't affect your credit score.

Last updated on May 4th, 2022 at 04:10 pm by Bill Tsouvalas

Car loans are sought out by Australians all across the country when it comes time for them to start looking to buy their next car. They make paying for your car more manageable, enabling you to pay for vehicles at your own pace. Fortunately, you can read all about them right here with Savvy before submitting your quick quote. Once you’ve decided on what you need, we can help you drive away in your new set of wheels in as few as 48 hours.

The ins and outs of car loans

What are car loans and how do they work?

A car loan is a loan or credit product that individuals use to purchase a vehicle. A lender, after conducting responsible lending checks, will approve a customer for a loan if they sufficiently meet their eligibility criteria. This loan is either deposited to the customer’s bank account or transferred directly to their dealer or seller. In return for this money, the borrower must pay back the lender with interest. 

The amount you borrow will be tied to the cost of purchasing your car, which must be manageable for you to repay on a monthly, fortnightly or weekly basis. You as a borrower can also decide the term over which you repay your loan, which ranges from one to seven years in length.

Additionally, the interest rate you’re offered on your loan will be dependent on several different personal variables, such as your job and income stability, credit score, history repaying similar loans and the type of car you purchase and its condition, as well as the Reserve Bank of Australia’s cash rate. Car loans always come with fixed interest rates, making them better for budgeting into the future as you’re protected against rate rises across your term.

What types of car loans are available?

It’s important to enter the car loan application process knowing exactly which product you need. As such, you should compare the different types of car loans thoroughly before settling on your finance type. These include: 

Secured car loans

The most common type of car finance, a secured car loan is specifically granted to an individual or dealer directly to pay for a car and take ownership immediately. These are secured or backed by the asset being purchased. Since it is backed by a security, interest rates are usually significantly lower compared with unsecured car loans.

Chattel mortgage and hire purchase

Chattel mortgages are for business customers who use a car for business purposes 50% or more of the time. Like secured car loans, a business takes out a loan and pays the car off over time. Hire purchases are functionally the same, but car ownership rests with the bank or lender during the loan term instead.

Novated leasing

Novated leasing is an agreement between an employee, their employer and a car dealer. An employee sacrifices some of their salary to go toward a new car, which they take ownership of straight away. This has the effect of reducing their take-home pay which can reduce their tax obligations as they pay the car off.

Unsecured car loans

An unsecured car loan (or personal loan) is a loan product which enables the borrower to gain a lump sum of money to spend on a large purchase. There is no security or asset tied to the loan. As a result, these loans carry a higher than usual interest rate. You may seek out an unsecured personal loan if the car you’re looking to purchase doesn’t meet your lender’s eligibility criteria, such as if it’s more than 25 years old or in poor condition.

Which factors affect your car loan repayments?

Three major factors affect your car loan repayments: your loan amount, the term of your loan, and the interest rate.

Loan size

As an example, you wish to buy a $30,000 car and have been approved for a loan with a 5.5% p.a. comparison rate. You have $4,000 for a trade-in and want to pay off the loan in five years. In this situation, your loan would effectively end up becoming a $26,000 finance deal at 5.5% p.a., which would cost approximately $496.63 each month.

Let’s say you put up more money for the car – a $4,000 deposit as well as your trade-in, totalling $8,000. In this case, it becomes a $22,000 loan with monthly repayments of $420.23. This means you’d save over $75 per month and almost $600 overall.

Loan term

To demonstrate the difference a loan term makes to your repayments, you can compare the cost of the same $30,000 car loan at 5.5% p.a. (without a deposit) over four years instead of five. Over five years, you’d pay $573.03 each month and $4,382.09 in interest and fees. However, while a four-year term would increase your repayments by over $100 to $697.69, you’d only pay $3,489.32 in interest and fees overall, saving you almost $900.

Interest rate

Finally, even the smallest difference in interest rate can result in a meaningful saving. As mentioned, a $30,000, five-year loan at 5.5% p.a. would cost you around $4,382.09 over the life of the loan. Reducing that rate by just 0.5% to 5% p.a. would see you pay $3,968.22, a saving of over $400. Increasing your rate by 1% to 6.5% p.a., on the other hand, would cost you $5,219.07 over five years, resulting in a greater outlay of over $800.

Fortunately, you can use Savvy’s car loan repayment calculator as a tool to help you work out how much your loan will end up costing based on all of these different variables. It’s useful to use this before you commence your application to give you an idea of what different loans cost and whether they’ll be affordable for you.

What insurance policy will I need to purchase for my car under finance?

When it comes to purchasing a car under finance, there’s only one option available to you in terms of car insurance, which is comprehensive car insurance.

Comprehensive car insurance covers damage caused by you to both your car and those of other drivers, regardless of who is at fault, as well as damage caused by theft and weather such as fire, flood and storm damage. You can also purchase optional additional cover such as roadside assistance, personal effects cover (for valuable belongings damaged or stolen in your car) and the arrangement of a hire car following an accident or theft. You’ll be able to select your own insurer when purchasing your car with finance, so you can ensure you’re locking in a high-quality policy.

Additionally, in all states and territories of Australia, you will have to pay compulsory third party insurance (CTP) along with your registration. This might be included with registration or must be purchased from a third party. This covers you for accidents in which you inflict injuries on other people, which isn’t covered by comprehensive policies, but doesn’t cover any property damage.

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Your car loan questions answered

How can Savvy help me save on my car loan?

We’re partnered with a wide range of lenders from across the country, so we take the legwork out of comparing and researching car finance deals to find the best one tailored to your individual needs. Once we’ve found a great car loan deal for you, we’ll handle your application to ensure it meets your lender’s criteria and sort out all the fine details before you’re ultimately approved. Best of all, the whole process can take as few as 48 hours.

Which documents will I need for my car loan?

When you apply with Savvy, we can help you get approved with only a handful of documents. These include:

  • Your last two payslips
  • Your driver’s licence or passport
  • Your Savvy application form
  • A signed consent form and credit guide (sent by your consultant)
  • 90 days of bank statements may be required depending on your lender
What are the fees I’ll need to pay?

There are several different fees which may apply to your car loan, so it’s important to consider these when choosing your deal. Fortunately, your Savvy consultant will compare these as well and pick out the most suitable and affordable loan for you. These costs include:

  • Application fee: between $100 and $600 (but can be waived)
  • Monthly service fees: between $5 and $20 per month (but can be waived)
  • Early repayment fee: up to $600 to $900 but dependent on the time left to run on your loan (can sometimes be waived)
  • Late repayment fees: between $25 and $50 per late instalment
Will a car loan improve my credit score?

It can – taking out a car loan and repaying it in a timely fashion will be recorded in your credit report as positive behaviour and can increase your overall score. You may find that if you took out your car loan at an average or low score, you might qualify for a lower interest rate on a different car loan in the future.

Can I sell my car during my loan repayment term?

Yes – however, you may need to pay a fee on top of your remaining loan balance to do so. You’ll need to ensure you have enough money to pay off the rest of your loan, particularly as the sale price of your car is likely to be comfortably lower than the price you paid for it even a few years afterwards.

What is a green car loan?

Green car loans are a type of loan incentivising people to buy environmentally friendly cars. These may have lower interest rates as the government is backing the initiative.

What is a bad credit car loan?

A bad credit car loan is a loan product that allows people with bad credit histories to gain car finance. These are usually at much higher interest rates, as they have a higher risk profile.

What is a balloon payment?

A balloon payment, also called a residual value payment, is a lump sum paid out at the end of a lease term or a car loan. For instance, if you took out a $30,000 loan over five years and chose to reserve $8,500 for a balloon payment, you will owe the lender $8,500 at the conclusion of your loan term. These are only really offered as an option for commercial car finance deals, however.