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How Does A Car Loan Work?

Explore the ins and outs of car loans to guide you through your next car purchase.
  Written by 
Adrian Edlington
Adrian Edlington is PR & Communications Manager at Savvy. With a keen interest in personal finance, car loans, the mortgage industry, cost of living pressures, electric vehicles and renewable technology, Adrian's research includes conducting primary data surveys and analysis of up-to-the-minute secondary Australian data sources. His work on behalf of Savvy has been featured on ABC.net.au The Conversation, the Sydney Morning Herald, AFR, News.com.au, The Age, Herald Sun, Adelaide Now, SBS On The Money, 7News, Car Expert, Which Car, Drive.com.au and more. In his spare time, Adrian enjoys mountain biking and business podcasts.
Our authors
 
  Reviewed by 
Bill Tsouvalas

Reviewer

Bill Tsouvalas
Bill Tsouvalas is the managing director and a key company spokesperson at Savvy. As a personal finance expert, he often shares his insights on a range of topics, being featured on leading news outlets including News Corp publications such as the Daily Telegraph and Herald Sun, Fairfax Media publications such as the Australian Financial Review, the Seven Network and more. Bill has over 15 years of experience working in the finance industry and founded Savvy in 2010 with a vision to provide affordable and accessible finance options to all Australians. He has built Savvy from a small asset finance brokerage into a financial comparison website which now attracts close to 2 million Aussies per year and was included in the BRW’s Fast 100 in 2015 as one of the fastest-growing companies in the country. He’s passionate about helping Australians make financially savvy decisions and reviews content across the brand to ensure its accuracy. You can follow Bill on LinkedIn.
Our authors

Published on December 15th, 2020

Last updated on April 29th, 2024



Fact checked

At Savvy, we are committed to providing accurate information. Our content undergoes a rigorous process of fact-checking before it is published. Learn more about our editorial policy.
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In this article

Car loans are one of the most common types of finance, with the Australian Bureau of Statistics (ABS) reporting that over $15.5 billion was lent for the purpose of purchasing a road vehicle in 2023. They enable you to pay for your car at your own manageable pace. Before you apply, however, it’s crucial to understand how they work and how to get them, which you can learn all about right here with Savvy today!

What are car loans and how do they work?

A car loan is a credit product designed to help borrowers purchase a vehicle. A lender, after conducting responsible lending checks, will approve an applicant for a loan if they meet their eligibility criteria. This loan is then transferred directly to their dealer or seller. In return for this up-front advancement, the borrower must pay back their lender with interest and fees.

The amount you borrow will be tied to your borrowing power, as well as the cost of purchasing your car. The loan must be manageable for you to repay on a weekly, fortnightly or monthly basis. You can also decide the term over which you repay your loan, which can range 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
  • Your credit score and history
  • Your savings
  • Your assets and liabilities
  • History repaying similar loans
  • The type of car you purchase and its condition
  • The Reserve Bank of Australia's cash rate

Car loans typically come with fixed interest rates, making them better for budgeting into the future as you’re protected against rate rises across your term. However, some lenders may allow you to choose variable rates, which may be beneficial in a market where rates are set to fall.

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 one which utilises collateral as part of the agreement. In this case, these loans are secured or backed by the car being purchased. Since it's backed by a security, interest rates are usually lower compared with other unsecured loans.

Chattel mortgage and hire purchase

Chattel mortgages are for business customers who use a car for commercial 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. As commercial products, however, these agreements come with a range of tax benefits, such as claimable interest and GST on the car purchase.

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 towards their new car, which they take ownership of straight away. This has the effect of reducing their take-home pay, which in turn reduces their income tax over the course of their lease term.

Unsecured car loans

An unsecured car loan (or personal loan) is a loan product without any security or asset tied to the agreement. As a result, these loans carry a higher 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.

What factors affect the cost of your car loan repayments?

There’s a range of variables that can impact the cost of your car loan and its repayments. These include:

Interest rate

Perhaps the most important cost factor on your car loan is your interest rate. Even small differences in rate can result in meaningful savings for the overall interest cost of your loan, as the table below demonstrates:

Loan size 7.00% p.a. 8.00% p.a. 9.00% p.a. 10.00% p.a.
$30,000
$5,643
$6,498
$7,366
$8,245
$40,000
$7,523
$8,664
$9,821
$10,993
$50,000
$9,404
$10,830
$12,276
$13,742
$60,000
$11,285
$12,996
$14,731
$16,490
$70,000
$13,166
$15,161
$17,186
$19,238

Interest totals are calculated based on a loan repaid monthly over five years.

Comparison rate

The comparison rate is a figure which combines both your car loan’s interest rate and primary fees, such as establishment and ongoing charges. This rate provides a more accurate reflection of the cost of your loan, as can be seen here:

Loan A Loan B
Interest rate
7.50% p.a.
8.50% p.a.
Fee %
2.5%
1%
Comparison rate
10.00% p.a.
9.50% p.a.
Total cost
$38,245
$37,803

Source: Cheap Car Loans – Savvy. Calculations based on a $30,000 car loan repaid monthly over five years.

Loan size

As shown in the table in the interest rate section, the more you borrow, the more interest you’ll pay. This is because interest is calculated based on your outstanding loan balance, which will remain higher if you opt for a larger loan sum. For instance, a $40,000 loan over five years at 7.00% p.a. will cost you almost $2,000 more than a $30,000 loan under the same terms.

Loan term

Shorter loan terms will result in lower interest charges. This is because your balance will fall at a faster rate. The following table outlines how loan terms can impact the cost of car finance:

Loan term Repayments Total interest Total saving
Seven years
$461
$8,653
N/A
Six years
$519
$7,347
$1,306
Five years
$602
$6,069
$2,585
Four years
$726
$4,818
$3,835
Three years
$934
$3,595
$5,058
Two years
$1,350
$2,400
$6,253
One year
$2,603
$1,233
$7,420

Calculations based on a $30,000 car loan repaid monthly with a 7.50% p.a. interest rate.

Although it isn’t necessarily realistic to opt for one year instead of seven, even opting for four years instead of five can save you around $1,250 at a cost of around $30 extra per week.

Extra repayments

Making additional payments on your car loan can not only impact its cost, but also the length of your term. The table below outlines how making additional payments can help you save and clear your debt sooner:

Loan term Extra payment Total payments Total interest Total saving Total loan term
Five years
$0
$602
$6,069
N/A
Five years
Five years
$100
$702
$5,019
$1,050
Four years, two months
Five years
$250
$852
$3,994
$2,075
Three years, four months

Source: How to Pay Off Your Car Loan Faster – Savvy. Calculations based on a $30,000 car loan repaid monthly with a 7.50% p.a. interest rate.

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 can cover 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.

Additionally, in all states and territories of Australia, you will have to pay compulsory third party (CTP) or green slip insurance along with your registration. This might be included with registration or required to be purchased from a third party. This covers you for at-fault accidents which cause injury or death to other drivers or people.

What to consider before taking out a car loan

Be mindful of “0% p.a.” or “1% p.a.” deals

Car loans with 0% p.a. or 1% p.a. interest are commonly advertised by car dealerships, but it's important to know what these deals actually are. The terms may include high fees, an inflated purchase price, expensive balloon payments and short low-interest periods of six to 12 months which revert to a high rate afterwards.

Pre-approval can improve your negotiating power

When shopping around for a new car, having a strong hand can work in your favour. Getting a loan pre-approved with a set spending limit means you have a price ceiling. When negotiating with a dealer, if they cannot match your limit, you have no choice other than to walk away. This can prove useful during the end of sales cycles, when dealers are eager to liquidate stock and meet quotas.

Are you buying new or used? 

A new car is more expensive than buying used; however, buying new could actually marginally improve the interest rate lenders offer you. New cars are more valuable and generally come with fewer risks, so lenders are more willing to lend to people who buy new. However, with such a small difference in many cases, the purchase price of the vehicle could make all the difference to your hip pocket. Weigh up which is more important to you before diving into the application process.

Deposits reduce your repayments

Having a deposit or trade-in when buying a new car can reduce your regular repayments substantially and improve your chances of lower interest rate approvals. With less of the purchase price of your car being payable with interest, the finance deal itself will be cheaper, and with more paid upfront, the lender is at a lower risk of losing out overall. Having equity in the car will lower your risk profile.

Know your credit history

Do you know your credit history? Find out where you stand before approaching brokers or lenders to understand your financial position. Having blemishes or defaults on your credit history may affect your ability to gain approval. Make sure you fix your credit history if it has any mistakes before applying. One of our experienced consultants will assess your application to help determine what the best available loan deal is based on your credit profile.

Some of your common 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 $0 and $600
  • Monthly service fees: between $0 and $20 per month
  • 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?

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.

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  Written by 
Adrian Edlington
Adrian Edlington is PR & Communications Manager at Savvy. With a keen interest in personal finance, car loans, the mortgage industry, cost of living pressures, electric vehicles and renewable technology, Adrian's research includes conducting primary data surveys and analysis of up-to-the-minute secondary Australian data sources. His work on behalf of Savvy has been featured on ABC.net.au The Conversation, the Sydney Morning Herald, AFR, News.com.au, The Age, Herald Sun, Adelaide Now, SBS On The Money, 7News, Car Expert, Which Car, Drive.com.au and more. In his spare time, Adrian enjoys mountain biking and business podcasts.
Our authors
 
  Reviewed by 
Bill Tsouvalas

Reviewer

Bill Tsouvalas
Bill Tsouvalas is the managing director and a key company spokesperson at Savvy. As a personal finance expert, he often shares his insights on a range of topics, being featured on leading news outlets including News Corp publications such as the Daily Telegraph and Herald Sun, Fairfax Media publications such as the Australian Financial Review, the Seven Network and more. Bill has over 15 years of experience working in the finance industry and founded Savvy in 2010 with a vision to provide affordable and accessible finance options to all Australians. He has built Savvy from a small asset finance brokerage into a financial comparison website which now attracts close to 2 million Aussies per year and was included in the BRW’s Fast 100 in 2015 as one of the fastest-growing companies in the country. He’s passionate about helping Australians make financially savvy decisions and reviews content across the brand to ensure its accuracy. You can follow Bill on LinkedIn.
Our authors

Published on December 15th, 2020

Last updated on April 29th, 2024



Fact checked

At Savvy, we are committed to providing accurate information. Our content undergoes a rigorous process of fact-checking before it is published. Learn more about our editorial policy.

This guide provides general information and does not consider your individual needs, finances or objectives. We do not make any recommendation or suggestion about which product is best for you based on your specific situation and we do not compare all companies in the market, or all products offered by all companies. It’s always important to consider whether professional financial, legal or taxation advice is appropriate for you before choosing or purchasing a financial product.

The content on our website is produced by experts in the field of finance and reviewed as part of our editorial guidelines. We endeavour to keep all information across our site updated with accurate information.

Approval for car loans is always subject to our lender’s terms, conditions and qualification criteria. Lenders will undertake a credit check in line with responsible lending obligations to help determine whether you’re in a position to take on the loan you’re applying for.

The interest rate, comparison rate, fees and monthly repayments will depend on factors specific to your profile, such as your financial situation, as well others, such as the loan’s size and your chosen repayment term. Costs such as broker fees, redraw fees or early repayment fees, and cost savings such as fee waivers, aren’t included in the comparison rate but may influence the cost of the loan. Different terms, fees or other loan amounts may result in a different comparison rate.

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