How Car Finance Works In Australia

When deciding to purchase a car, there are many things to consider, including whether to buy new or used, price range and what model and year is a perfect fit for you.

However, the top of the list is how you are going to pay for it.

If you do not have the cash to purchase a car outright, finance is a viable option.

However, it is important to understand the basics of how car finance works, in order to help you make the best possible decision.

When you apply for a loan, the lender will conduct a range of responsible-lending checks, to ensure you meet their eligibility criteria to receive the finance. These include whether you work full-time, your income, your debts (other loans/mortgage) and you ability to repay the loan, taking into account all your other regular expenses

Once approved, the loan amount is either deposited directly into your bank account, or transferred directly to the dealer selling the vehicle.

In return, the buyer contacts themselves to repay the lender the total amount borrowed, plus interest, usually over a set time period.

Repayments are usually made on either a monthly, fortnightly or weekly basis over loan terms of between one and seven years.

The interest rate you pay on your car loan depends on current economic conditions and official interest rates, plus your risk to the lender. This is where your credit score and previous loan history are taken into account, plus the type of car and its value that your are looking to finance.

Car finance often comes with a fixed interest rate, making it easier for the borrower to manage future payments over the loan term. It is also a safety buffer against the prospects of future interest rates rises.

Perhaps the easiest option to purchase a car is dealer finance -- a convenient choice for someone who wants a hassle-free process, where the salesman or dealer finance team sets up a lender and a loan as part of the purchase process.

Alternatively, a buyer can use a finance broker, who will try to arrange the most suitable lender for that customer's unique circumstances, and help them through the process.

Sometimes, car purchasers seek to complete the financing on their own, applying for a personal loan with a lender with which they already have a personal relationship, such as a major bank that may have financed their mortgage.

Key things to consider before choosing to finance your new car include:

Types of Car Finance

• Secure car loan: This is the most common type of car finance, where a secured car loan is granted to an individual directly to pay for a car of their choice and take immediate ownership.
• Chattel mortgage: Are used for buyers looking to purchase a vehicle for a business, in which the business takes out a secure loan, and the ownership of the vehicle remains with the bank or lender for the duration of the loan term.
• Novated leasing: This is an agreement between an employee, their employer, and a car dealership. The employee sacrifices some of their salary to go toward paying for the new car. The employee takes ownership of the vehicle and, in exchange, they agree to reduce their take-home pay as they pay the car off.
• Personal loan: This is also known as an unsecured loan, which enables the buyer to acquire a lump sum that is transferred directly to the borrower to pay the dealer for their new car. There is no asset tied to the loan. These loans usually carry a higher interest rate and are often used by borrowers who do not meet the eligibility criteria needed for a secure car loan.

Lender

A traditional lender could be a bank or credit union that caters to customers who meet their eligibility criteria to secure a loan. They typically deal with customers who have good credit scores and reliable incomes and, in exchange, they may offer highly competitive borrowing rates.

A non-traditional lender could be a financial institution that offers a lower barrier of entry to qualifying for their loans but offset that with higher interest rates. They generally cater for people who are ineligible for a loan from a traditional lender, maybe because of a low credit score or a less suitable form of income. Here, it is important to assess how high the interest rate may be, as well as other payments or penalties (such as late payment fees) that may be associated with the loan.

Deposit

This is the amount you pay upfront at the time you purchase your car, in order to secure the vehicle before the loan balance comes through to pay the balance. The advantage of paying a higher deposit is that it reduces your ongoing monthly repayments during the loan term. The bigger the deposit you pay, the more options you have, and it can also lead to a reduction in your interest rate. You also have an option to trade in a vehicle for a set amount, in order to increase your deposit.

Principle

This refers to the amount of money that you agree to repay the lender. Interest is charged based on the principal amount you owe over the duration of the loan term. By reducing the principal, you can reduce the amount of interest payable.

Interest Rate

This is often described as the cost of borrowing from a lender. It can be either a fixed or variable interest rate. With a fixed-interest loan, your repayments do not change for the duration of your loan term. The benefit of this is that you know exactly how much your repayments will be each month, and it allows you to better manage your budget. Car dealerships usually offer fixed-rate loans. With a variable interest rate, your repayments can change as official interest rates change. In the case of an increase in official bank interest rates -- such as over the past three months -- your repayments may increase. Unlike a fixed-term loan, variable-rate car loans usually do not have an early exit fee. They may be better for buyers looking to make extra repayments over the loan term, or looking to pay off the remaining amount before the final date on the contract.

Loan Term

The term of your car loan can be as short as three years, or as long as seven. A longer term means you make repayments for a greater period of time. That makes your monthly repayments smaller, however, you pay more in interest over the loan term. Various loan terms are designed to help an applicant tailor their monthly repayments, to make it easier to manage their finances. Lenders can also determine loan terms based on a car's age (a car cannot be older than 15-20 years at the end of the loan term), as well as the applicant's budget and interest rate. When using a longer-term loan, you usually would not have much equity in the car until closer to the pay-off date, which may impact the benefit of selling or trading in the car before the loan term has ended.

Generally speaking, a car loan with the lowest possible interest rate, and little to no associated fees, is best. However, it is important that you do your own research and compare offers of different lenders. Some advertise attractive deals but may make up for it with additional fees and costs.

You should look for the lender's comparison interest rate, because this takes into account any upfront and ongoing costs through the loan term.

At the end of the day, a good car loan is one that helps you purchase your new vehicle quickly and easily, provides the flexibility to manage your budget, and take delivery of your new car when you need it.

Advice given in this article is general in nature and is not intended to influence readers' decisions about investing or financial products. They should always seek their own professional advice that takes into account their own personal circumstances before making any financial decisions.