Written by , updated on July 5th, 2023
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Find out about what variations there are in financing your next car with Savvy.
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Most of us will need a car loan when buying a new car. There are many options out there – personal loans, secured loans, and variable or fixed rates. In this guide, we’ll take the mystery out of all these terms and tell you in plain English what you can expect from each of these options.
In personal finance and buying an asset such as a car, you may be given the option of unsecured or secured finance. Choosing one or the other may impact how much you can borrow and what your final interest rate will be.
A secured car loan ties the value of the loan to the car, known as a security. This security, also known as an asset, when held against the value of the loan, reduces the risk on the part of the lender when they approve a car loan. The lower risk means a lower interest rate for the borrower, compared to a personal or unsecured loan of the same term and amount. Lenders will also only lend you the amount necessary to cover the cost of the car, up to your borrowing limit. This is determined by your credit score and income.
Personal loans are a type of unsecured loan that are not tied to a car or asset (security.) That means you can apply for a personal loan and spend the money as you like – but you will still have to pay back the loan as agreed. Unsecured personal loans mean that a bank or lender cannot repossess your car if you fall behind on payments and default. In exchange for this, your interest rates will be higher than a comparable secured loan. These are far less common, as a car is a ready option as a security.
Yes – you can get a car loan to finance the purchase of a used vehicle. However, some lenders may charge more interest due to higher risks. Buying new has more advantages for the lender and the borrower as the borrower has more residual value in the car to begin with. Some used car loans may have low rates and low fees and more flexible payment terms. This depends on the borrower’s individual situation.
Bank and non-bank lending (traditional) loans make up most of the finance available when buying cars. However, there are some alternatives out there that you may want to consider.
Other options for people looking to finance a car are Peer-To-Peer finance (P2P.) P2P finance links borrowers with private lenders directly. According to the Australian Securities and Investments Commission, $300 million has been financed by P2P lending over Financial Year 2018-19, which also includes personal lending and mortgages. These come in a variety of options such as unsecured and secured loans, fixed vs. variable rates, and other features depending on a borrower’s risk profile, income, demographic, geography, and other factors.
A novated lease is also known as “salary sacrificing.” This is a three-way agreement between a lender, an employer, and employee. An employee will set aside some of their pay packet to finance the car, which may have the added benefit of bumping the employee’s salary into a lower tax bracket.
If you are a homeowner with an active mortgage, you can use a line of credit or redraw facility to finance a car. Despite a smaller interest rate compared with a consumer car loan, you could be paying more in interest due to the long-term nature of a home loan.
Car dealer finance is also an option, though this may cost you more compared with a consumer car loan due to how these loans and packages are structured. Read more about car dealer finance here.
Before you set out looking for a car, you need to know your budget. How much can you realistically spend on one, when fuel, insurance, and registration are all factored in?
Do you want the flexibility of an unsecured loan or the lower interest rate of a secured loan? Do you need fixed payments or are you willing to risk higher repayments later for low ones now during a lull in official interest rates?
How much you can afford in repayments each month will let you know what type of loan term may suit. If you can absorb higher repayments, you can choose a shorter loan term.
Before applying for any type of loan, it’s best to check your credit score and history. If you have errors on your history, you can clear them up before applying and potentially save on interest.
A car loan broker like Savvy is your best bet to find a car loan that suits your needs, as they can draw upon different loans with varying features and competitive rates.
You may have come across the term “balloon payment” when searching for your car loan. It is most popular or often used by sole traders or small businesses. Balloon payments are also known as residual value payments. This is a portion of the car loan amount set aside for immediate payment at the end of the term. This varies from 20-50%. The upside of having a balloon payment attached to your loan is that your regular repayments are lower, but you will need to come up with the lump sum quickly (up to a month or two) to close out the loan. You can also refinance the lump sum, but this may attract more interest.
The rates in fixed vs variable rates refer to how the interest rate is calculated from one repayment period to the next. Fixed rate car loans are loans with interest rates that are consistent across the term of the loan. This means you “lock in” a rate from the beginning to the end of the loan. Variable loans can go up or down depending on the market rates. Variable rate car loans are harder to budget for; each month or repayment period you amount payable could be different. If you buy a car while the market is high and goes low, you could end up paying less. Of course, this is hard to predict and makes budgeting harder.
In car finance, the most common loan term is five years or 60 months. With most lenders, you can choose your loan term to suit your needs. Shorter loan terms attract less interest but have substantially larger repayments. Longer terms mean more interest and lower monthly repayments – as you are making more repayments. For example, a $30,000 loan at 5.75% with a three-year term will mean $909 in monthly repayments. The same amount and interest rate over seven years will mean $435 in repayments. However, you will pay $3,779 more in interest with a longer term.
If you have been rejected for car finance or suspect you may be rejected, you can still get a car loan by using a guarantor. A guarantor is a family member or trusted friend with good credit who offers to take responsibility for the loan if you are unable to pay it back. You “piggyback” their good credit score and gain approval with a bigger budget and/or lower interest rate than what you’d be normally entitled to. However, any missed payments or defaults will also effect your guarantor’s credit history, so make sure you are aware of all the consequences.
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