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How do car loans work?

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Getting a car on finance

It's safe to say that most people want to own a car. Travelling to and from school, the office and other destinations is a lot more convenient if you have your own vehicle.

But it can be expensive, and not everyone has the money to pay for a car up front in cash. Thankfully, they can apply for a low interest rate car loan to finance the car instead.

A car loan is a loan taken out for the purpose of buying a car. If you haven't got enough in savings to buy a car, but you can afford to repay a loan in monthly instalments, you may want to consider taking out a car loan to finance your new set of wheels.

A car loan allows you to borrow a certain amount of money to buy a car. In return for the loan, you pay interest to the financial institution that lent you the money.

You need to pay back the loan within a certain period of time (called the term) which ranges from three to five years at loans.com.au. This is the amount of time over which you agree to pay back the loan, usually in monthly installments.

In addition to repaying the amount you borrow, you will also be charged interest. You can try our car loan calculator to work out approximately how much your car will cost you over the term of your loan. 

The key components of a car loan:

As you can see, there are several components which make up a car loan. We'll cover these in more detail below.

Interest rates

Interest is the biggest cost of a car loan, so it's the first thing you should look at when considering a car loan. The interest rate will be expressed as a per annum figure, calculated regularly on the outstanding loan balance.

Before borrowing money for a new car, you should always know what the interest rate is and compare car loan rates being offered by a number of different lenders.

At loans.com.au, we offer fixed rate car loans which mean interest rates remain the same for the duration of the term regardless of what's happening in the market or changes made by the lender.

Loan period

The loan period or term at loans.com.au can be as short as three years or as long as five years. A longer term essentially means you'll be paying off the loan for longer, but your monthly repayments will be smaller. You will pay more in total interest though.

Car loan repayments

Car loans are most commonly paid off monthly, but you can ask your lender if they will allow you to make weekly or fortnightly repayments if that suits your financial situation better.

Making more frequent repayments can help you pay off the loan a lot sooner and with less interest.

Other car loan fees and charges

There are several other fees you could be charged that can add significantly to the loan amount. These include an upfront/establishment fee, ongoing fees, the break fee, discharge fee, and late payment fee.

Balloon payment

A lot of car loan borrowers opt to have a balloon payment in the loan. A balloon payment is an agreed upon lump sum that is paid to the lender at the end of the loan term.

Borrowers who want smaller, regular repayments can opt for a balloon, but over the life of the loan their total interest costs will be higher.

The lender

You need to get a car loan from somewhere, and many of the points above will influence which lender you choose to go with.

What are your options for a car loan?

There are three main options when it comes to buying a car on finance. Firstly, you can take out a car loan through the car dealer. While dealer finance can be convenient, and requires no planning, their car finance rates are often higher. This can add significantly to the overall cost of the loan.

Another way is through a bank. Finally, you can apply for a low-rate car loan from an online lender. The key to making use of a low-rate car loan is to get pre-approval from the lender before you go the the car dealership. This allows you to resist any pressure from the dealer to use their finance.

It also takes away a bargaining chip that the dealer can use to extract a higher price for the vehicle, as you will not be dependent upon them supplying your finance, and will not need to divulge your borrowing capacity.

Whichever option you choose, make sure you have shopped around for the best rate. The best rate these days is often with a non-bank lender such as loans.com.au so you don't want to regret going with dealer finance, and paying too much for both the loan and the car.

Car loan application

What do you need to finance a car loan?

You will have to provide the following when getting final approval for a car loan:

  • 100 points of ID: This may include your drivers license, passport, Medicare card, etc.
  • The details of the vehicle: The make and model, registration number, engine number and purchase price, and whether the vehicle is new or pre-owned.
  • Proof of income: You may need two or three recent payslips as well as proof of employment, your employer's contact information, and two years worth of tax returns if you're self-employed.
  • Assets and liabilities: This may include details of any properties you own, any other loans you may have, your ongoing expenses, and any other debts (such as credit card debts).

Find out more about documents required to apply for a car loan.

How can you get the best car loan?

Make sure you compare car loans from different lenders. Check the interest rates, charges, and the amount that you can borrow.

To find out how much you need to pay on a regular basis, you can use a car finance calculator. It will also show the total interest you will pay based on the loan amount and frequency of payment.

One important thing to note is that a car finance repayment calculator should only be used as a reference. Since there are other factors that can affect your car loan, make sure to seek advice from a car loan expert.

What makes a good car loan?

Generally speaking, a car loan with the lowest possible interest rate, and little to no fees (low comparison rate) is best.

However, you should be mindful to look at more than just the interest rate. Some lenders advertise a low rate on the loan, but make up for it with exorbitant fees instead.

That's why it's important to look at the comparison rate as well, because the comparison rate factors in upfront and ongoing fees. In addition, different car loan features can also help such as the ability to make flexible or extra repayments.

Some incidental fees aren't factored into the comparison rate, so it's worth looking into these as well so that you aren't caught out if you need to pay them.

Other Car Finance Resources: 

About the article

As Australia's leading online lender, loans.com.au has been helping people into their dream homes and cars for more than 10 years. Our content is written and reviewed by experienced financial experts. The information we provide is general in nature and does not take into account your personal objectives or needs. If you'd like to chat to one of our lending specialists about a home or car loan, contact us on Live Chat or by calling 13 10 90.

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