How do car loans work?
If you’re in the market for a new or used car, there are a number of financing options available. If you do not have the savings to buy one outright, an option you may be considering is taking out a car loan. Before you sign up for one though, it can be important to understand the basics, including what car loans are and how they typically work.
Key points:
- A secured loan is one where you offer ‘collateral’ (such as the car itself) to provide more security to the loan provider
- A fixed rate car loan is where the interest rate is locked in for the entirety of the loan
- Car loans may be offered by a range of financial institutions either as a standalone car loan or as a personal loan
What is a car loan?
A car loan is a type of personal loan taken out for the purpose of buying a new or used motor vehicle such as a passenger car, van, truck, motorbike, ute or 4WD. A car loan may also be called a vehicle loan.
These loans may be secured or unsecured. A secured loan is one where you offer ‘collateral’ (such as the car itself) to provide more security to the loan provider in case you fail to repay the money you have borrowed within the agreed timeframe. If the sale of your collateral does not cover the full amount you owe, you will have to pay what is left directly to the lender.
Unsecured loans, on the other hand, do not require any collateral. Instead, the lender will rely on your credit score to approve the loan. Unsecured loans generally have higher interest rates than secured loans and you may not be able to borrow as much.
How do car loans work?
When you enter a contract for a car loan, the amount of money you borrow has to be paid back within a certain period of time (called a term), usually in regular repayments. The length of the term can vary, typically from around 12 months to 10 years, depending on the lender you choose and the agreement you reach with them.
In addition to requiring you to pay back the amount you borrow, lenders will also charge you interest on the balance, at either a fixed or variable rate, plus any fees and charges.
A fixed rate car loan is where the interest rate is locked in for the entirety of the loan. On the other hand, a variable rate loan is where the lender may change the interest rate during the term.
While choosing a variable rate car loan may mean you could pay less interest if rates are cut, it also means you run the risk of the lender increasing the rates during the term, leaving you paying more for your car loan. As such, it’s important to consider the pros and cons of these rate options before diving in.
Some car loan lenders may offer reduced monthly repayments if you agree to pay a one-off lump sum, or balloon payment, at the end of the loan term. Consider whether the total repayments on the loan will be higher with the balloon payment than without, before making your decision.
It’s also worth noting that, depending on the type of agreement you have with your lender, if you want to make extra payments from time to time and pay out your loan early you may be charged an early termination fee. Check with your provider to see what account fees and charges may apply.
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Compare Car Loans with Canstar
If you’re currently considering a car loan, the comparison table below displays some of the car loans on our database with links to lenders’ websites that are available for used cars. This table is sorted by Star Rating (highest to lowest). Products shown are for a loan amount of $20,000 in NSW with a loan term of five years. Consider the Target Market Determination (TMD) before making a purchase decision. Contact the product issuer directly for a copy of the TMD. Use Canstar’s car loans comparison selector to view a wider range of car loan products. Canstar may earn a fee for referrals.
Products displayed above that are not “Sponsored or Promoted” are sorted as referenced in the introductory text and then alphabetically by company. Canstar may receive a fee for referral of leads from these products. See How We Get Paid for further information.
Canstar is an information provider and in giving you product information Canstar is not making any suggestion or recommendation about a particular product. If you decide to apply for a car loan, you will deal directly with a financial institution, not with Canstar. Current rates and fees are displayed and may be different to what was rated. Rates and product information should be confirmed with the relevant financial institution. For more information, read our detailed disclosure, important notes and additional information. *Read the comparison rate warning. The results do not include all providers and may not compare all the features available to you. Canstar may earn a fee for referral of leads from the comparison table. See How We Get Paid.
Cover image source: Skrypnykov Dmytro/Shutterstock.com
This is an update of an article originally written by Elise Donaldson.
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