How Do Car Loans Work: Navigate Car Financing Like a Pro

January 25, 2024

How do car loans work, and why do they matter? Before getting car financing for your dream wheels, it’s important to know how these loans roll.

We all know Australians have a thing for cars, belonging in the top ten countries for car ownership worldwide! In May 2021, Australians snagged $1.296 billion in car loans. That’s a lot of four-wheeled dreams coming true!

We have created this guide to help you understand the intricacies of car financing. We’ll discuss the factors affecting your monthly payments, credit score, loan terms, etc. So, let’s get started!

What Are Car Loans?

Car or auto loans allow individuals to acquire a car by borrowing money and paying it off in instalments. The most common car buying method in Australia is through car loans, where the life of the loan typically takes three to five years.

Different Types of Car Loans

Here are the many options you can consider before getting a car loan:

Car dealer finance

Dealer financing from car dealerships involves borrowing money and buying a car right from the dealership. It helps you get the car faster and sometimes with lower interest rates.

However, a balloon payment may be required at the end of the finance period. This is the lump sum principal balance due at the end of your loan term. This type of loan usually works for new cars only.

On the other hand, regular car loans can be used for new and used cars from private sellers or other dealerships, giving you more options.

Mad Man Motors offers financing options if you want to buy a car. Start your finance enquiry here.

Personal loans

Personal loans are unsecured loans not linked to any collateral for security on the lender’s side. You can spend the money how you want, but you’re responsible for paying it back. Since there is no item as collateral, the interest rates might be higher.

They’re less common because cars can be used as collateral for loans with lower rates. If you get a personal loan for a car, your credit score matters more.

Lenders focus more on your financial situation to decide if you qualify. So, it can be harder to get for those with a low credit score.

Standard loans

Many financial institutions like banks, credit unions, and other lenders in Australia offer standard car loans. These loans come with varying interest rates and terms. While they’re simple, you must be financially stable and ready for additional costs such as interest, fees, and penalties.

Here are examples of car loans from different providers:

• RateCity provides car loans starting at 4.99% interest.
• First Option Bank offers loans for buying new or used cars under seven at a 10.99% yearly interest rate.
• People’s Choice offers adaptable, low-interest car loans for new and used cars.
• Credit Union SA provides loans for cars less than two years old, both new and used.
• MoneyMe offers unsecured car loans up to $50,000 with competitive variable interest rates.

Commercial hire purchase

Commercial hire purchase involves the financier purchasing the vehicle on behalf of the customer and then hiring it back to them. The customer can use the car for the contract term but doesn’t own the vehicle yet.

At the end of the contract term, when you have paid the vehicle’s total price (minus any residual) and the interest charges, you can take ownership of the car.

Commercial hire purchase loans in Australia are offered by several financial institutions, including:

• CarLoans.com.au
• Rapid Finance
• Stratton Finance
• Bank of Queensland

Finance lease

A finance lease is when someone rents a vehicle from a finance company by making fixed monthly payments for a specific period. From the start, the finance company owns the car, and the person leasing it is responsible for paying back the loan.

Here’s how it works: the finance company buys the vehicle for the person and then rents it back to them. Although the person using it doesn’t own the vehicle, they can use it throughout the lease. When the lease ends, they might choose to buy the vehicle or return it to the finance company.

Peer-to-peer loans

In Australia, peer-to-peer lending, or P2P lending, is a different way to get money for car loans or personal loans. Instead of going to a bank, these P2P platforms link people who need cash with lenders or companies willing to lend it. These individual lenders decide whether to lend money based on the borrower’s application.

Usually, P2P lending platforms might have lower maximum loan amounts of around $30,000 to $35,000. They may also offer more flexible terms for who they lend to, with actual people reviewing your application instead of following strict bank rules.

Mortgage redraw

Redrawing means taking back the extra amount of money you’ve put into your home loan. It reverses the progress you made by paying more on your loan. Making extra payments can shorten your loan term and save on interest.

However, redrawing could erase these benefits. It might prolong your mortgage, delay owning your home, and miss out on potential savings. Also, using redraw might involve fees. There could also be a limit on how much you can take out, which may not be enough to cover the total cost of your car.

Novated lease

A novated lease is a common way to finance a car, letting employees use their salary to pay for it. The deal is set up with the employer, and the car loan repayments come from the employee’s salary before taxes are applied.

This might lower the employee’s taxable income, which could mean paying less tax. The pre-tax deductions usually include expenses like maintenance, fuel, and insurance. However, not all employers provide this benefit, so it’s essential to check if it’s available.

Things to Consider Before Applying for Car Loans

When comparing car loans, it’s important to consider several factors beyond just the monthly payment. Here are some factors to compare car loans effectively:

The total cost of the vehicle

The total cost of a vehicle includes more than just its purchase price—it involves expenses like interest and insurance. Knowing this total cost helps you understand the financial commitment of the loan and pick a car that fits your needs and budget.

On top of that, monthly car maintenance costs range from $66 per month to about $800 per year. Yet, these costs depend on the car’s make, model, age, and mileage.

Oil changes, tyre rotations, and brake pad replacements are crucial for a car’s performance and safety, and their expenses accumulate over time.

Length of the loan term

The average duration for car loans falls between 5 and 10 years.

This term significantly impacts monthly payments and interest. Shorter-term loans mean higher monthly payments but less interest overall.

Conversely, longer-term loans have lower monthly payments but lead to increased interest costs. Longer-term loans might be more manageable due to lower monthly repayments, but they eventually accumulate higher overall interest.

Meanwhile, shorter-term loans demand higher monthly payments but potentially save thousands in interest payments.

The amount you can deposit

When seeking car loans, the initial deposit amount is crucial to consider.

A larger down payment at the start of buying a car can reduce the borrowed amount, reducing monthly payments if you buy a car worth $25,000.

With a larger down payment of $5,000, you’d only need to borrow $20,000. This reduced borrowed amount can lead to lower monthly payments.

Additionally, the loan-to-value (LTV) ratio is the difference in the loan amount to the car’s value, which affects loan terms and interest rates.

A lower LTV ratio often leads to better loan conditions. For instance, if the car’s value is $30,000 and you take a loan for $20,000, your LTV ratio would be 2/3 or 67%.

However, if you borrow $25,000 for the same car, the LTV ratio becomes 5/6 or 83%. A lower LTV, such as in the first example, can often result in more favourable loan terms and lower interest rates.

While some lenders may request a deposit, obtaining a car loan without one is possible. Lenders might ask for a deposit if you lack a credit history, possess a poor credit record, or have negative equity from a previous car loan.

Depositing even a few thousand dollars can significantly lower interest payments over the loan’s lifespan, saving hundreds in interest expenses.

How much can you pay monthly

Your monthly budget is the best way to determine what you can afford. Use a car loan calculator to explore various loan amounts and interest rates to estimate your manageable monthly payment.

However, it’s advisable to wait until you’re comparing lenders before settling on specific figures.

Experts suggest allocating a maximum of 10% of your monthly income for the car payment. Then, around 15% to 20% for overall car expenses, including gas, insurance, and maintenance.

Vehicles’s purpose

Before completing the car loan application, you should have clear motives for wanting to own a vehicle. These reasons could vary, such as commuting to work, seeking convenience and comfort for business (Uber or Bolt), going on road trips, or simply using it as a status symbol to showcase personal success.

For example:

• Sedans are versatile and cater to individuals, couples, or small families. They are budget-friendly options and typically accommodate up to 5 passengers.
• Vans come in diverse sizes and serve multiple purposes, whether for transporting passengers or carrying cargo. They are well-suited for larger families or businesses transporting multiple passengers or goods.
• SUVs are ideal for long journeys and have the capacity to accommodate up to 10 passengers. Known for their robustness and comfort, they’re suitable for off-road excursions and transporting sizable items.

Best Practices Before Getting a Car Loan

Check your credit score before visiting the dealership

Clearing debts and timely payments boost your credit score, reducing interest on your car loan. A high credit score impacts the loan options available. A score of 670 or higher qualifies for top-tier loans, securing better terms, lower rates, and larger loan amounts.

Compare financing options offered by dealers with rates from other lenders

Securing an auto loan through a bank often means accessing lower interest rates, even without an account. However, this process might take longer and be more restrictive for those with average credit.

Dealerships partner with various lenders, including large banks, online lenders, and credit unions, sometimes through their financing divisions or captive lenders owned by major auto manufacturers.

If your credit isn’t top-notch, dealerships can be a favourable option, as they cater to diverse credit profiles.

They might offer better terms than your bank or qualify you for financing even if a bank didn’t approve your application. Challenging the dealer to beat your preapproved bank rate could also lead to more favourable terms.

Get loan pre-approval

Before car shopping, obtaining preapproval for a loan from a lender with favourable terms is a smart move. This step involves receiving a quote specifying the approved loan amount, usually up to a certain limit.

With a preapproval letter from the lender, you can use it as leverage during car negotiations. Ask the dealer if they can offer better financing than your preapproved loan. Having multiple loan options empowers you to consider the best financing available.

Sometimes, upon preapproval, the lender may issue a blank check. This check allows you to write an amount up to your preapproved limit when you find the desired car, streamlining the purchase process at the dealership.

FAQs

How Do I Qualify for a Car Loan?

Lenders typically consider factors like your credit history, income stability, and employment details to qualify for a car loan. A steady income, good credit score, and manageable debt-to-income ratio often increase your chances. Meeting these criteria helps lenders assess your ability to repay the loan.

Can I Get a Car Loan with Bad Credit?

Yes, you can still get a car loan with bad credit, although it might come with higher interest rates or stricter terms. Some lenders specialize in loans for individuals with poor credit. So, exploring these options could help you secure financing despite your credit situation.

What Happens If I Can’t Make My Car Loan Payments?

If you can’t make your car loan payments, it can lead to consequences like late fees, increased interest, and vehicle repossession by the lender. Letting the lender know about financial difficulties may help explore potential solutions and avoid consequences like losing the car.

Can I Negotiate the Terms of a Car Loan?

Yes, you can negotiate various car loan terms, from the downpayment interest rate to the loan term. You can also shop around and compare offers from different lenders. This can provide leverage to negotiate more favourable terms that suit your financial situation.

What Is the Interest Rate on a Car Loan?

The interest rate on a car loan varies based on factors like credit score, loan term, and the lender. Typically, rates range from around 3% to 10% or more.

A higher credit score often secures a lower interest rate, impacting the overall cost of borrowing for your vehicle purchase.

Final Take on Car Loans

Now that you’re familiar with down payments and handling interest rates in car loans, you’re closer to driving your dream car. Understanding how car loans work can truly empower you, turning you into a seasoned pro when it comes to car financing. You’ve taken in a lot of information, but don’t fret if it all feels a bit overwhelming.

It’s a process, and you’re well on your way. Remember, knowledge is power and you’ve got what it takes to navigate this journey like a pro.

Now that you’re equipped with this knowledge, it’s time to put it into action. Why not explore the variety of car loan options at Mad Finance? Our dedicated team is ready to guide you through, ensuring you make the best decision for your financial situation. Don’t just dream about that new car, make it a reality with Mad Finance. Take the first step today!

Mad Man Motors and Mad Finance are here to cater to both your car needs and financing. Browse our inventory of vehicles and simplify your financing process with us today!