Car loans: what are your options?

Finance Writer · 14 July 2021
Looking to buy a car? There’s a chance you’re going to need a car loan to help you.

Buying a car is not an everyday event, nor is applying for finance to fund your big purchase. You might be considering car finance if you don’t have the cash to pay upfront. With several different financing options out there using their own special terms and lingo, it’s easy to feel confused. So, we’ve rounded up a few car loan types in this guide to help you compare in deciding the best option for your needs.

In this guide, we explore:

What are the different types of car loans?

Much like car models, car loans also come in different shapes and sizes to suit a range of borrowing needs. Whether you’re a cash-poor student needing a reliable mode of transport or you’re looking to upgrade the family car as the family grows, some car loans are more suitable than others. Some of the more common types of car loans include:

Bear in mind, as a car’s value can depreciate over time, car loans can be considered a ‘bad debt’ to have (compared to a home loan which could be considered ‘good debt’). However, if you’re in need of a new car and you haven’t got enough money saved, then a car loan may be appropriate.

Getting a car loan through a financial institution

Getting a car loan through a financial institution, such as a bank, credit union or building society, can bring benefits. For example, you may be able to organise pre-approval for your loan so you can go car shopping with a firm idea of what your budget is. You might also be able to negotiate the amount you can borrow or a repayment term that suits your needs.

However, if you are considering a car loan from a financial institution, you’ll need to make sure you can afford to make the repayments, which include repaying the amount borrowed plus interest and potentially fees too. It may hurt your credit score if you miss any car loan repayments.

If you choose a traditional lender for your car loan, make sure you compare a range of loan products, so you can find the best deal. Every year Canstar assesses the costs and features of hundreds of car and personal loan products on its database and gives them a Rating from one to five to reflect the value they offer overall. Shopping around 5-Star Rated car loans could help you save money over the life of the loan.

There are several other choices to be made when it comes to choosing a car loan to suit your needs.

New or used car loans

Car loans can be taken out to buy new or used cars from private sellers, at auctions, or from car dealerships. For new and newish cars – usually up to around three years old – you may find some financial institutions offer secured car loans.

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.

Secured car loan or unsecured personal loan

Most lenders will secure newer model cars against the loan to protect them from the risk of borrowers defaulting on repayments. Because of the reduced risk to lenders, secured car loans tend to attract cheaper interest rates than an unsecured personal loan.

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.

Fixed or variable interest rate

With a fixed rate loan, the interest rate on the loan stays the same throughout. This means repayments stay the same, so may be easier to budget for. However, there may be additional fees involved 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.

Green loans

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 compared to equivalent non-green loans.

Alternative finance options to help you buy a car

Financial institutions aren’t your only financing option when buying a car. Common alternatives include peer-to-peer loans, car dealership financing, novated leasing, rent-to-own cars and using your mortgage redraw or home equity.

P2P finance

Peer-to-peer (P2P) lending allows people to borrow funds from investors via an online platform. While the source of the loan is different to a bank loan, P2P loans work in a similar way, with interest and sometimes fees charged. The cost of these loans can vary from provider to provider, so it is a good idea to shop around. Your credit score may also have an impact on the interest rate you are offered.

Car dealership financing

Some car dealerships offer on-site financing for their cars through the lenders with whom they have a relationship. Dealer financing can appeal as a convenient option because you may be able to find a car, take out finance and drive away on the same day.

However, it’s best to shop around before signing anything. As the dealer takes care of the entire loan process for you, it can be difficult for you to know if you’re really getting the best deal. Dealership loans can also sometimes be more complex than a traditional loan. For example, you may be offered an appealing interest rate but be required to make a lump sum ‘balloon payment’ at the end of your loan term. A balloon payment usually means lower monthly repayments, but the overall cost of the loan could still be higher than paying making a higher regular repayment with no balloon payment.

Novated lease

A novated lease (also known as ‘salary sacrificing’ a car) is a three-way agreement between you, your employer and a finance company, in which your employer agrees to make lease repayments for a car to a finance company using your pre-tax salary. The pre-tax deductions generally also cover operational costs, such as maintenance, fuel and insurance.

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. Not all employers offer this perk, so you’ll need to explore if this is an option for you. It’s important to consider the pros and cons of car leasing carefully before committing.

Rent-to-own cars

Similar to leasing, a rent-to-own car is one you agree to rent for a set period of time while making regular repayments as part of your commitment to buy it. Repayments contribute towards the rental costs as well as the eventual purchase of the vehicle, usually requiring you to pay a lump sum amount at the end of your agreement.

While they can be a relatively easy and fast way to get your car, the Australian Securities and Investments Commission (ASIC) warns on its Moneysmart website that some rent-to-buy arrangements can end up costing consumers more in the long run. You might be charged extra costs, such as a dishonor fee, costs for damaged or stolen items, and termination fees or charges. Moneysmart says you could also be offered insurance or a warranty for an item you rent, but that this is optional and you could already be covered under Australian consumer law. You should check what it covers and the cost if you are considering this option.

Mortgage redraw / line of credit

If you’re a homeowner, you might be able to dip into any extra repayments you have made on your mortgage via a redraw facility or use a separate line of credit to finance a car. The benefits can include potentially saving on interest, as well as the convenience of not having a separate car loan. However, you could end up paying more in interest on your home loan in the long run and it could take you longer the pay the loan back if you don’t make extra repayments to account for the increased balance.

Make sure you shop around and explore all car financing options available to you. It’s important to understand the benefits, risks and fees involved to determine what’s the right fit for your needs.

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