Car finance options: What type of car loan should you get?

What are the different types of car loans?

Car loan finance comes in various forms, such as:

• Secured or unsecured loans from banks and lenders
• Peer-to-peer (P2P) loans
• Dealer finance
• Novated leases
• Rent to own financing

Each option works differently, and may suit certain borrowers more than others. If you’re looking for car finance, understanding the different types of car loans can help you find the right fit.

Getting a car loan through a financial institution

Many banks, credit unions and building societies offer car finance. To qualify, you typically need a good credit score and demonstrate the ability to repay the loan.

The amount you can borrow and the interest rate you’re offered will also depend on several factors, including the type of vehicle you choose (such as a new or used car), and whether you choose a secured or unsecured loan. Car loan from financial institutions can differ depending on key factors like::

Whether the car is new or used

Car loans can be taken out to buy new or used cars. New car loans are often secured against the car you purchase, reducing the lender’s risk and potentially your interest rate.

Used car loans relate to cars that are too old to qualify for a ‘new car loan’ according to the lender’s standards. These tend to be offered as a personal loan and not a standalone car loan, as the value of the loan isn’t secured against the car.

Whether the loan is secured or unsecured

Most lenders secure newer model cars against the loan to protect them from the risk of borrowers defaulting on repayments. That’s why secured car loans usually come with lower interest rates than unsecured personal loans.

If you take out an unsecured personal loan to buy your car, the lender relies more heavily on your credit score and finances to assess your ability to meet repayments. This can make this type of loan more difficult to apply for, especially for those with a poor credit score.

Whether the interest rate is fixed or variable

With a fixed rate loan, your interest and repayments on the loan stay the same, making budgeting easier. Keep in mind, though, that fees may apply if you want to make extra repayments and pay out the loan early.

On the other hand, a variable interest rate can fluctuate whenever the lender changes its interest rate. This can be beneficial when interest rates go down, but as Moneysmart suggests, you’ll want to be sure you can still make repayments if the interest rate goes up.

Whether the car qualifies for a green loan

Some lenders offer ‘green loans’ to borrowers who are purchasing a more environmentally-friendly vehicle, such as a hybrid or an electric car. These loans can come with lower interest rates or fee discounts compared to traditional home loans.

Alternative finance options to help you buy a car

P2P finance

Peer-to-peer (P2P) lending allows people to borrow funds from investors via an online platform. They work much like bank loans, with interest and sometimes fees charged. The actual cost can vary by provider, so it could help to shop around. Your credit score can also affect the rate you get.

Car dealership financing

Some car dealerships offer on-site financing for their cars through select lenders. Though convenient, consider shopping around before signing up for this option for the best possible rate. Also check the structure of the loan, as you may be required to make a lump sum ‘balloon payment’, which can make the overall cost of the loan higher.

Novated lease

With a novated lease (also known as ‘salary sacrificing’ a car), your employer agrees to make lease repayments for a car to a finance company using your pre-tax salary.

At the end of the novated lease period, you can generally decide whether to keep the car and pay the residual value (as a balloon payment), extend the current lease, or sell your leased car and use the money from the sale to pay the residual value. Keep in mind that not all employers offer this perk.

Rent-to-own cars

A rent-to-own arrangement lets you rent a car with regular payments that go toward its eventual purchase. You’re usually required to make a lump-sum payment at the end of the agreement to own the car.

It’s worth noting that a rent-to-own car doesn’t involve borrowing any money, which means the provider may not carry out a credit check. This may seem appealing, but the Moneysmart website warns that some rent-to-buy arrangements can end up costing consumers more in the long run.

Mortgage redraw / line of credit

If you’re a homeowner, you could use extra repayments via a redraw facility or use a separate line of credit to finance a car. This can help you save on interest charges, as home loan rates are often lower than car loans, and avoid taking out a separate car loan.

However, using your mortgage this way can increase your overall interest costs and extend your repayment period if you don’t make extra repayments to account for the increased balance.

Can you get pre-approved before choosing a car?

If you choose to finance your car from a bank or lender, you can usually apply for a pre-approval for your loan. This could help you get an idea of how much you can borrow and go shopping for your car with a firm budget.

Remember that pre-approvals generally last for a set period, typically one to three months. However, a pre-approval doesn’t guarantee your loan will be approved, as the lender will once again check your financial situation before approving your loan.