How Does a Car Loan Work

How Does a Car Loan Work

If you are planning to buy a new or used vehicle using a car loan, it is important to understand how they work.

Most auto loans are simple interest loans. The Principal is the amount you borrow to buy your vehicle. The Interest is the fee you pay to the finance company that lent you the money for borrowing the principal.

Simple interest car loans are paid down via amortisation, which means you pay more interest at the start of the car loan than at the end of your payoff date.

The loan term normally ranges from 36-60 months, during which you need to pay back the loan. Generally speaking,  having a weekly payment will help pay the loan faster compared to a monthly payment.

What are your choices for a car loan?

Not many people pay for their cars with cash upfront. Here are some of the options you can choose from to finance your vehicle:

  • Dealer – If you buy a car in the car yard, the car dealer may offer a car loan. While this might sound very convenient, the rates may be higher than the other options. It’s best to look around and compare loans to make sure you get the best loan available.  
  • Online lenders – This is the most convenient and simple way to apply for a car loan. You can fill in an online application and get a pre-approval so you know how much you can spend when you walk into a dealership to buy your car. Once you have decided on a car, the paperwork can then be finalised and downloaded. Then funds can be sent directly to your dealer so you don't have to carry cash or purchase a bank cheque for the car.
  • Banks – Another common way to purchase a car is by borrowing money from a bank. An advantage of this could be familiarity if you’ve worked with your bank before. However, the downside is that most of the banks charge a monthly fee.

How to get the best car loan?

Many experts advise you to compare car loans prior to getting your car. Here’s how you can compare car loans to get the best deal:

  • Compare interest rates – Search for a financial institution that will lend you money at a competitive rate.
  • Compare fees - Ensure you check what fees are payable upfront, during and at the end of the loan term.
  • Compare the amount you can borrow – Factors like income, credit reports, and the type of vehicle can influence how much a lender will offer you. Make sure the lender you choose will give you the amount you need.
  • Use a car loan calculator – This will help you understand how much your car loan monthly repayments will be on the amount you are borrowing.

Car loan advice

To avoid financial pitfalls when looking for a car loan, it is best to check your current financial situation, check your credit score, and determine what kind of vehicle you can afford. Don’t forget to compare different options to finance your car to ensure that you get the best deal for your individual situation.

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