By Mitchell Watson, Group Manager of Research and Ratings at Canstar
If you’re in the market for a new or used car you will likely spend some time exploring the different vehicles on offer. While it is important to find the right car for your needs, whether it’s for your private use or for sharing with others, it is also important to research the different finance options available to make the purchase.
If you don’t have a large sum of cash or savings for your new wheels, you may have to consider borrowing. In Australia there are a range of loan options available, each with their own benefits and drawbacks.
A car loan is money you borrow from a bank, credit union, or independent lender to buy a new or used car. The amount you borrow has to be paid back within a certain period of time (called a term), which can vary from 12 months to 10 years depending on the agreement, and interest must be paid at either a fixed or variable rate.
Fixed or variable rate?
If you choose a fixed rate car loan, your repayments will stay the same for the term of the loan, whereas for a variable rate car loan your repayments may change if your lender chooses to raise or lower their interest rates, which can be influenced by market conditions.
While a fixed rate loan offers the benefit of set repayments and protection from interest rate increases, if you choose to occasionally make extra repayments to pay out the loan early and save money on interest, you may be charged additional fees. Each loan is different, so check the loan terms before proceeding.
When making your decision, also consider the current interest rates, any upfront or ongoing fees associated with the loan, your budget, and if you would be able to make increased repayments on a variable loan if the interest rate were to rise.
Secured or unsecured?
For a secured car loan, you will need collateral that will act as your ‘security’, such as your car. Basically, this gives the lender more security as they will be able to claim the collateral to help recover the debt should you fail to make repayments. With this added security, these loans tend to carry lower interest rates for borrowers. However, if you don’t make your repayments on time, you can have your car (or other form of collateral) repossessed, and if the sale of that collateral does not cover the full amount you owe, you will have to pay what is left directly to the lender.
An unsecured car loan does not require collateral as security. Instead, the lender will rely on your credit score to approve the loan. This can make these loans a little more complex to apply for, especially for people with a poor credit history. Unsecured loans generally have higher interest rates than secured loans because the lender is taking a bigger risk. They may also have borrowing limits and shorter loan-repayment terms than secured loans.
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. Also consider whether you can afford to pay this lump sum amount at the end of the loan term.
Peer-to-Peer Personal Loans
An alternative to taking out a personal loan through a bank or customer-owned institution is choosing a peer-to-peer (P2P) lender.
P2P lending is an online platform that cuts out the middleman (your traditional lenders), to allow people to borrow funds directly from investors, who can be individuals or corporations. The platform operator itself typically makes money through charging fees to the borrowers and investors.
Once you are registered to the platform and have gone through the security and credit assessment checks, you can expect to be matched up to an investor. From there, if you qualify for a loan, the platform will coordinate the lending process for your personal loan. Generally, the interest rate you pay on the loan will be dependent on your risk profile - the higher the assessed risk, the higher the rate paid.
Some P2P loans may offer competitive interest rates, depending on the risk profile, and can have a convenient online application process. However, they can carry upfront and ongoing fees and may offer shorter loan terms and lower loan amounts compared to traditional lenders. P2P loans can be either secured or unsecured, depending on the platform.
Read the terms and conditions of the P2P platform and product before committing.
If you are purchasing a car from a dealership, they may be able to arrange a loan for you through their own bank or lender.
The potential benefits of dealer finance include the convenience of buying and financing a car at the same time, and having the dealer handle the paperwork to process the loan.
However, keep in mind that if the dealer takes the majority of the control in arranging the finance it may be hard to know if you are getting the best loan on the market for you. The dealer may also charge you a fee for providing the service of arranging finance for you. It is important to check what’s on offer elsewhere to make sure this type of financing suits your needs and budget.
5 considerations when financing your car
Consider the following when comparing loan options for your new car:
- What is the interest rate and how is it determined?
- Are there any upfront or ongoing fees to pay to the lender? E.g. establishment fees, monthly account-keeping fees and statement fees. Some of these fees may be avoidable, for example accessing your statements online rather than having them posted to you.
- Is there a balloon payment to pay at the end of the loan and can you afford it?
- Flexible terms – can you decide on the length of the loan and repayment schedule?
- Can you repay the loan earlier without incurring early termination fees?
Before choosing a finance option for your new car, it’s important to shop around and compare what’s on offer so you can make the right choice for your needs and budget.
Remember to read the terms and conditions of each loan to understand the benefits, risks and fees involved.
Once you have purchased your car, it is a good idea to consider car insurance.
About Mitch Watson
Mitch Watson is Group Manager of Research and Ratings at Canstar. He has been working in finance research for over 10 years. Over this time he has developed a deep understanding of financial products and what consumers and businesses need to be looking for to get ahead.
This advice is general and has not taken into account your objectives, financial situation, or needs. Consider whether this advice is right for you. Consider the product disclosure statement (PDS) before making any financial decision. For more information, read Canstar’s Financial Services and Credit Guide (FSCG).
If you’re looking for a way to help cover your car’s costs, why not put it to work but renting it out when you’re not using it yourself?