How Does a Car Loan Work?If you’re looking for a car loan, you’re probably wondering ‘how does car finance work?’. This article explains everything you need to know about borrowing to buy a new or used car. It includes answers to the most frequently asked questions (FAQs) from our expert brokers at Auto Car Loans.
What is a car loan?
A car loan is finance to help you buy a car. It’s one of the most common types of finance in Australia. Australians are currently taking out more than $1.2 billion worth of loans per month to buy road vehicles. Plenty of those loans are for cars!
Many people simply don’t have the money to pay cash upfront to buy a car. Others take out car finance for business purposes.
Taking out a car loan involves getting finance for either part or the full purchase price. Borrowers may provide some or no deposit to the lender. The money that they borrow is repaid via regular repayments over a set loan term.
Car loan repayment amounts depend on:
- lender interest rates and fees.
Higher interest rates and fees result in higher repayments for the same loan over the same term. You will be charged a higher interest rate if you have a poor credit score. You will only have a bad credit score if you have a record of not making credit repayments on time. You might also be charged a higher interest rate if you’re buying a used vehicle rather than a new one, whether or not you own property, and the amount of deposit you are putting in to the loan. This is because a new vehicle will usually have a higher resale value and presents less risk to the lender.
Different lenders also charge different interest rates. There are a huge number of lenders in the Australian car finance market and it’s crucial to do your research to get the best deal. A car finance broker can help you to do that.
Use the comparison rate when comparing loans. This is the rate including all lender fees and charges. Lenders are legally required to include the comparison rate when advertising their products.
You should try and get your finance pre-approved with a bank or other lender BEFORE you walk into a car yard. This will give you more negotiating power. It will also help you to avoid dealer-arranged finance that usually has a higher interest rate.
- the loan term.
Standard car finance terms in Australia are between 1 and 7 years. The average term is 5 years. The shorter the term, the higher the repayments will be for the same amount borrowed with the same interest rate and fees (and vice versa). For example, your repayments on a $30,000 car loan over 3 years would be higher than those for the same amount over 7 years at the same interest rate.
- the amount borrowed.
The more you borrow over the same finance term, the higher your repayments will be (and vice versa).
- the repayment frequency
Car finance repayments are normally monthly, but with some lenders you can also arrange fortnightly or weekly repayments. Making weekly or fortnightly repayments can help you to pay off your loan faster.
- whether or not you include a balloon payment.
A balloon payment is where you arrange a shorter finance term that includes lower regular repayments and one large repayment at the end. For example, you might buy a $30,000 car and arrange to pay $20,000 over 5 years with a $10,000 balloon payment at the end. Your regular repayments will be lower over the 5 years than if you were arranging to repay $30,000 without any balloon payment.
A balloon payment can therefore help to make your regular repayments more affordable and allow you to pay off your loan faster.
What is a secured car loan?
A secured car loan is one where the vehicle is provided as security for the lender. This type of security is known as collateral. This means that the lender can repossess the car if repayments aren’t made. The lender can then sell it to repay the amount owing.
The alternative to a secured car loan is an unsecured one. Unsecured car finance doesn’t doesn’t require the vehicle (or any other asset) to be put up as security to the lender. This means that it couldn’t be repossessed, though the lender may take other legal action against you if you don’t make your repayments.
An unsecured loan typically has a higher interest rate to compensate the lender for the lack of security. This means that you will pay more for your car by taking out an unsecured loan than a secured one.
Fixed vs. variable rate car loans – what’s the difference?
A fixed rate car loan has an interest rate that is fixed for some (or all) of the finance term. This means that the interest rate won’t change during the fixed rate period. It gives you certainty over what your repayments will be.
No one has a crystal ball to predict future interest rate movements. However, interest rates in Australia are currently at record lows, and may not be able to go much lower. Some analysts are predicting a rise in the next couple of years.
All car loans across our panel of over 50 lenders are based on Fixed interest rates. This helps give you certainty knowing your monthly repayment for the entire loan term.
Here are the answers to some other common questions that we get from our clients Auto Car Loans.
Can a car loan be deducted on taxes?
Car finance can be tax-deductible if you buy a vehicle for business purposes. It cannot be deducted if you’re buying a car solely for private use. If you will use your vehicle for both private and business use, you can claim the work-related portion.
There are different rules depending on whether you’re running a business or whether you’re an employee. We’ll look at each situation in turn.
If you’re running a business
If you finance your car through a chattel mortgage, you can usually:
- deduct the GST on the purchase price if your business is registered for GST.
- immediately write-off the full purchase price if you meet eligibility requirements.
- claim a tax deduction for loan interest.
Once your car is paid off, the mortgage is removed.
If you’re an employee
If you’re an employee and you need a vehicle for business purposes, you can still qualify for a chattel mortgage to pay less tax. Most lenders require you to provide a letter from your accountant which confirms you will be using the car for predominant business use.
Can a car loan be paid off early?
You can pay off a vehicle loan early if you want to. For example, paying off your finance with a 7-year term in 5 years. Most car loans are paid out before the full term expires.
However, most (but not all) lenders will levy an early payout penalty. You should check the loan’s terms and conditions to see if there are any early repayment charges.
Ways to pay off a car finance early include:
- making extra repayments.
For example, making a lump sum payment when you get a tax refund or some other financial windfall.
- trading up your car.
Many borrowers will replace their existing car with a new one during the loan term. This involves trading in the old car to pay out the existing loan and -most often- getting a replacement loan to finance the new car.
- refinancing your existing car finance to a shorter term.
For example, if you have a 7-year loan that still has 5 years to go, you could refinance it to a 3 year time. This could be a good option if you can afford the larger repayments. It could also be a good option if you can refinance to a lower interest rate. Note refinancing is subject to lender policies and can include early termination charges.
Can a car loan be transferred?
If you have a secured car loan, the vehicle is part-owned by the lender until the finance is fully repaid. The loan cannot be transferred to another person without lender approval.
If you have an unsecured car loan, the vehicle is not provided as security for theFprec finance. You can sell the vehicle while you still owe money on it, but you will still be liable to make your repayments. Again, the loan cannot be transferred. If the buyer needs finance to buy the vehicle, they can apply for their own loan.
You can privately sell or buy a car with money owing on it. This is known as buying an encumbered vehicle. Dealers can only legally sell cars that have no money owing on them (an ‘encumbrance’ or ‘charge’). For private sale vehicles, the lender will check the Personal Property Securities Register (PPSR) to make sure there are no loans held against the vehicle being sold. If there is an charge against the vehicle, the incoming lender will insist on a payout statement from the outgoing lender. This allows the incoming lender to directly pay the outgoing lender and clear any charge.
Can a car loan be transferred to another bank?
You can’t transfer a loan, but you can apply to refinance a car loan with another bank or other financial institution. If your application is approved, your original finance will be fully paid out and you will have a new loan. This can be a good option if the interest rate and fees are lower on your finance with the new lender.
However, you should check if there are any early repayment fees with your original lender. You need to make sure that the refinancing benefits outweigh the cost.
Can a car loan be restructured?
Restructuring a car loan involves refinancing it with your current lender (or a new one). It may be a good option if either your personal circumstances or market conditions have changed.
For example, you could restructure/refinance your loan to:
- one with a lower interest rate and/or fees.
- a shorter term if you want to increase your repayments to pay it off faster.
- a longer term if you want to lower your repayments.
Refinancing to a longer term is a better option than falling behind in your repayments. If you do, it can damage your credit score. This will make it harder for you to borrow money in the future. Falling behind in your repayments can also lead to your vehicle being repossessed if you have a secured loan.
Note that any refinance will be subject to lender policies.
Can a car loan be preclosed?
Preclosing a car loan is financial jargon for paying it off earlier than the finance term. For example, paying off a 5-year loan in 3 years. Most lenders will allow it, though they may charge early repayment fees. Any early repayment fees will be disclosed in the loan’s terms and conditions. You should do a cost/benefit analysis to work out if paying out your car finance early will be beneficial for you.
Can a car loan garnish your wages?
If your vehicle is repossessed because you have fallen behind in your repayments, a lender may also ask for a court order to garnish your wages. This means that your employer will be legally required to pay a part of your wages to the lender instead of you. This step is a last resort. It will usually only happen if the lender will be unable to recoup the amount you owe by selling your repossessed car.
How we can help
If you’re looking to buy a new or used vehicle and you need finance, talk to us at Auto Car Loans. We’re finance brokers with access to over 50 lenders, including all the big banks. It’s our job to review your application and find you a great deal.
Don't use dealer-arranged finance or try to arrange a car loan yourself. If you do, you could end up paying a lot more. We arrange vehicle finance for a living. We work for our clients, not for lenders.
Call 1300 301 051 during business hours to speak with one of our experienced brokers.
DISCLAIMER : The thoughts and opinions conveyed on this website are those of the authors only and are of a general nature. This does not constitute financial or general advice to you from Auto Loans Group. You should seek your own independent advice from a professional which is specific to your circumstances before considering any of the items referred to in this article, including finance, insurance, and car buying.