A car loan works in theory just like a home loan, personal loan, commercial loan, or any other type of loan. A bank or financial lender will loan a sum of money to allow you, the lendee, to purchase your chosen vehicle.

However, there are some differences in car loans - in eligibility, applications, terms, and the type of loan chosen.

What is a Car Loan?

A car loan will enable individuals to purchase the motor vehicle they want, with the help of a lender. Rather than paying or saving for the vehicle purchase amount, car finance allows the individual to purchase the car right away, and repay the lender over a certain period of time.

How Do Car Loans Work?

As mentioned, individuals seek car loans to buy a vehicle without paying the entire amount upfront. The idea is that the lender will provide the funds to purchase the vehicle, and you will pay it back, with added interest, over a certain period of time (called the “term”). There is an agreed upon term, and repayments are often made at regular intervals - whether it be weekly, fortnightly, or monthly (also agreed upon at the beginning of the loan).

Types of Car Loans

There are different types of car loans that are offered by banks and lenders. The most common types of car loans include:

Secured vs. Unsecured Car Loans

The main difference between a secured and unsecured loan is security, as well as interest rates. A secured loan ties the loan's value to the car, using the car as collateral to provide the lender security and reduce risk. This also means you will likely receive a lower interest rate. An unsecured loan does not tie the car to the loan as security, which can result in a higher interest rate.
Fixed vs. Variable Interest Rates

Fixed and variable interest rates can significantly affect the overall cost of a car loan, so it’s important to know the difference. A fixed interest rate is when the interest remains constant and does not change throughout your loan repayments. A variable interest rate fluctuates with the market, which means your repayments can vary.

There are pros and cons to each interest rate option. Fixed interest rates offer security and allow for repayment forecasting/better budgeting, but there is the risk of being locked into a higher interest rate. A variable interest rate can increase with the rise of interest rates, but it also decreases when interest rates go down; so you could end up getting lower interest rates throughout the loan term.
Balloon Payment Loans

A balloon payment car loan is a large lump sum that you agree to pay the lender at the end of the car loan’s term. This type of loan lowers weekly, fortnightly, or monthly repayments until the final balloon payment is due.

Key Components of a Car Loan

Understanding the key components of a car loan can help to make an informed decision when applying for a car loan.

Loan Term

The loan term is the amount of time the receiver has to repay the car loan with interest. The shorter the term, the higher the repayments are, but the lower the total interest paid. A longer loan term means lower repayments but a higher total interest. Car loan terms generally range from 12 months to 7 years, depending on the agreement and type of car loan you choose. For example, an unsecured loan often has a shorter loan term than a secured loan because the risk is greater for the lender.

Interest Rates

The interest rate is the amount you are charged in addition to the repayments, making it a major cost factor. Interest rates depend on the lender’s policies, the type of vehicle you purchase, and your credit score. A good credit score is often more attractive to lenders, so you may be offered lower interest rates, whereas a lower credit score can mean a higher interest rate over the car loan.

Repayments & Fees

The repayments of a car loan include the principal (amount borrowed from the lender) and interest. Additional fees can apply to cover the costs lenders incur when managing the loan. Fees can include credit checks, legal services, establishment, administrative tasks, and charges to discourage behaviours like early repayments and late fees.

How to Lower Your Car Loan Costs

Yes, a car loan is ideal if you do not have the funds to purchase a car from your personal savings. However, it is more favourable if you’re able to put forward a portion of your own funds or reduce your car loan, so you’re not paying higher than necessary rates. 

Below are some things you can do to lower the cost of your overall car loan.

  • Make a Larger Deposit: A larger deposit may be more difficult to save up for, but it will reduce the total loan amount – leaving you with lower interest and smaller repayments over the loan term.
  • Choose a Shorter Loan Term: A shorter loan term pays off the vehicle faster with less interest over time – saving you from paying higher interest rates on your car.
  • Compare Lenders: There are plenty of lenders out there, so make sure you do your research. Compare rates, lowest fees, and flexible features to find the best loan for you.

How to Compare Car Loan Offers

Use a Loan Calculator

Using a loan calculator can help to estimate car loan repayments based on different loan terms, amounts, and types.

Check the Comparison Rates

Checking and comparing each lender’s rates, including interest and fees, will provide a clear picture of costs. Some lenders charge higher interest rates and fees than others, so when you compare lender’s rates, you can clearly see which lender offers the best car loan.

Look for Extra Features 

Some lenders offer extra features that can provide more flexibility to your car loan. Additional features include:

  • Redraw facilities: If needed, you can make extra repayments to reduce the interest, with future access to these funds.
  • Flexible repayments: You can withdraw funds from your loan as required and repay it once you have extra funds.
  • Early payoff options: Early repayments lower how much you will spend on interest. Lenders may allow you to make additional repayments or pay off your car loan entirely before the end of the loan term.

What You Need to Apply for a Car Loan

Applying for a car loan can be a relatively hassle-free process if you provide the required documents and follow the right steps.

  • Proof of Identity: Driver’s license, passport, or other government ID that states your full name, age, date of birth, and citizenship information.
  • Proof of Income & Employment: Two most recent payslips, bank statements showing your income and outgoing expenses for the last three months, and tax returns (for self-employed).
  • Vehicle Details: Make, model, registration, purchase price, and contract of sale or dealer invoice, which includes address, contact number, and ABN.
  • Debt & Expenses Assessment: Information on other loans (mortgage or personal loans), and summary of investments and superannuation.

Common Mistakes to Avoid When Taking a Car Loan

Not Comparing Rates & Terms

Comparing rates and terms among different lenders will ensure you get the best car loan offer. When you skip this step, you may be hit with hidden fees or higher interest rates.

Opting for a Long Loan Term

Long loan terms may seem attractive due to the lower repayments each week, fortnight, or month. However, long loan terms have higher interest rates than short loan terms – significantly raising the overall cost of the loan.

Ignoring Fees & Charges

Some lenders require additional fees and charges, like an establishment payment, early repayment fees, and late payment fees. These fees and charges can add up and cause the cost of your car loan to soar.

Not Using a Broker

A car finance broker can provide a wealth of knowledge and experience to the table - a broker can compare the rates for you, provide specific advice to the right product based on your financials, and help put you in touch with lenders beyond the big banks.

Final Thoughts: Choosing the Best Car Loan for You

A car loan that balances affordability, low fees, and flexibility generally makes for the best car loan option. You can do this by comparing car loans, looking at the fine print to avoid hidden fees and unexpected costs, looking at the overall payment in the long term as opposed to small repayments in the short term, and finding lenders who provide flexibility. Consider your financial situation and future repayment ability to help you find a car loan that meets your needs and works for your financial situation.

Beforeuloan is Australia’s leading finance and mortgage broker network who can put you in touch with the right car finance broker. If you require a car loan, reach out to Beforeuloan today or browse our educational pieces, so you can understand everything you need to know before you loan.