Determining how much you can borrow for a car loan is based on how much you earn, how much you spend each month, and your credit habits. This calculation is used to figure out your borrowing power – how much you can afford to pay back to a lender each month or repayment period.
According to the Australian Bureau of Statistics, by the end of 2018 Australians had financed vehicles to the tune of $1.23 billion. ASIC MoneySmart says the average car cost in Australia is $27,994 with the average loan amount totalling $18,049.
Your borrowing power is determined by looking at your income and expenses and seeing what is left over to service (pay back) a loan.
Let’s take this as an example: If you earn $100,000 a year and spend about 60% on essentials like rent/mortgage, bills, groceries, etc. this means you have $40,000 in disposable income. You may use about 20% of that on disposable purchases like nights out, movies, sports days, holidays, etc. This leaves you with $20,000 left over.
$20,000 in disposable income could demonstrate you can comfortably pay back a $50,000 loan over five years without running into any financial difficulty (provided you don’t lose your job, fall ill, etc.)
Using this example, if you take out a five-year loan for $50,000 with a $4,000 deposit, your borrowing power ranges between $868-$1,047 per month. Owing more each month might put you in financial trouble, which a lender is bound by law not to do.
A lender will not simply lend out $300,000 for a luxury vehicle to someone who earns $50,000 a year, even if their credit is spotless – this would put the borrower at risk.
Yes – creditworthiness is expressed as a credit score by the major credit reporting agencies. ASIC MoneySmart says a credit score is “a number based on an analysis of your credit file, at a particular point in time, that helps a lender determine your creditworthiness.”
Your credit score is an aggregate or expression of how risky you might be as a borrower. Your credit history will list which lenders you owe money to and how much, how much credit you have borrowed, how many times you’ve applied for credit, unpaid debts or maxed out credit, and any court orders or agreements related to unpaid debts or bankruptcy.
Most credit agencies, the bodies that prepare your credit reports, give you a score between 1200 and 0. (Some provide a number between 1000 and 0.) If you have a high score, you are deemed more “credit worthy.” If you have a low score, you are more of a risk and may be in the “bad credit” or “below average” category. For example, applying for credit in many places and being rejected shows lenders you may be desperate for credit and could have trouble paying them back. This all drops your credit score.
This can hinder your attempts for credit approval and may mean you have to prove your creditworthiness in other ways. Even so, lenders may only give you a loan with a higher interest rate as this is “insurance” against not being paid back (known as defaulting.)
A lender will conduct a “soft” credit check – which does not go on your credit file – to assess whether you are eligible for a car loan. This is part of responsible lending practices which is there to protect consumers.
Using this publicly available information, a lender can determine whether you are a risky borrower or not. Some lenders may offer you a preliminary interest rate so you can do your first set of repayment calculations. It is a check to verify you are who you say you are. This is also known as loan “pre-approval” or “approval in principal.”
Before making a “hard” or formal credit inquiry with a credit reporting agency, you may volunteer payslips, employment statements, bills in your name that you have paid, and other financial statements to show you can afford to pay back a loan.
The formal credit inquiry confirms the lenders’ assessment of a borrowers’ creditworthiness. Depending on how good or bad the history is, they may offer you a lower (or higher) interest rate.
Low interest rates aren’t the be all and end all of saving money on a car loan. A lender can advertise the lowest of the low interest rates, but it doesn’t mean you’ll be paying less over time in repayments. Some interest rates may be low but when expressed as a comparison rate, which includes most fees in the percentage, the costs are much higher.
Looking at your repayments instead of looking at interest rates will give you a clearer picture of how much the loan “costs” and how much you can budget for. This is a fixed cost and can be factored into how much you can afford to borrow, once registration, insurance, fuel costs, and other on road costs are considered.
Using a car loan calculator can give you a general idea of how much you can expect to pay each period. All you need to know is the comparison rate you’re likely to pay and how much you want to borrow. The calculator can be useful in figuring out your own borrowing power.
Checking your credit history helps you understand your borrowing power before a lender makes any sort of judgment. If your credit history has mistakes or defaults that aren’t your fault, you can use this opportunity to correct them. It could save you thousands in interest.
Having payslips to confirm your income is always a plus when you apply for a car loan. This proves your creditworthiness in an additional way apart from just checking your credit score.
If you have supplementary income or can prove you are responsible with savings, this can further aid your car loan application. If you have more disposable income than what your initial assessment shows, it could improve what interest rates are available and/or your borrowing power.
Showing lenders you are responsible with bills and residency (e.g. not moving often) can also tip the scales in your favour.