Even if you're a little strapped for cash, car loans can help you score the car of your dreams – be it a classic sports car, a practical hybrid, an SUV or just a dependable means of getting from A to B. But given the myriad of financing options and eligibility requirements, choosing the best car loan can prove to be an intimidating task. Below, we break down the basics of car financing so you easily can compare car loans without driving yourself dizzy with unfamiliar terms.
New car loans vs used car loans
Whether you're looking to buy brand new or purchase a used car, there are lots of car financing options to choose from. However, it should be noted that some lending bodies impose a maximum car age for second-hand vehicles. Aside from this, there are other ways that new and used car loans differ as well. These factors should be taken into consideration well before you go car-hunting.
- Overall car loan amount and repayment terms. Since a used car will most likely be cheaper than a new car, used car buyers won't have to take out massive loans to finance their vehicles. Paying off used car loans is usually faster too, since used car loans typically have shorter terms than new ones.
- Interest rates and comparison rate (sometimes called the APR). When it comes to interest rates, new cars are at an advantage. Due to the higher resale value and lower likelihood of breakdowns, a new car loan is often given a lower interest rate and comparison rate (which includes the effect of loan fees). Some lenders even offer a 0% interest rate on new cars, although such loans may have higher fees or see you paying a top price to purchase the car.
- Limitation on age of used cars. Lenders may refuse to financed used vehicles that will be more than 12 years old at the end of the loan term. So if, for example, you need a loan term of five years, your chosen vehicle cannot be more than seven years old at the beginning of the loan term.
- Sales, special rates, and discounts. Holiday sales, year-end sales and store anniversaries are great opportunities to buy a new car at discounted rates. Unless you're buying from a dealership, you're not likely to encounter these kinds of special rates when buying a used car.
- Depreciation. They say that a new car loses value the minute it's driven off the lot. In some estimates, a new car can lose up to 40% of its value within the first year. Meanwhile, a used car takes much longer to depreciate since the previous owners have taken the brunt of the blow.
Secured vs unsecured car loans
Distinguishing between secured and unsecured car loans is pretty straightforward. A secured car loan is a type of loan where the lender reserves the right to repossess an asset should the borrower fail to meet their loan repayments. In short, the asset – typically the car being purchased – is used as collateral. An unsecured car loan, on the other hand, doesn't require any type of asset to be used as a security.
While the thought of having your car taken away can be pretty daunting, it's something you should get used to, as secured car loans are far more common than unsecured ones. After all, banks and other lending parties need some kind of assurance that they won't sink their companies to the ground by giving out loans.
There are advantages and disadvantages to either type of car loan. Though unsecured car loans may seem less risky for the borrower, they usually come with much higher interest rates than secured ones. Again, it's all about lenders needing to minimise risks. Typically, there's a one and a half to three percent difference between interest rates for secured and unsecured car loans. Check out our car loan comparison chart above to see what we mean.
And while an unsecured car loan is usually the better option for financing a used car, borrowers need to make sure they've got decent credit scores. Otherwise, you might be better off applying for a secured car loan.
Types of car finance
There is more than one way to gain financing for a car. Here are the six most common types of car loan.
- Standard car loan. As its name suggests, this is a typical bank or credit union car loan where you and your lender agree on an interest rate as well as a fixed loan amount and term. Early repayment may or may not be allowed. Standard loans are great for people who are looking for the simplest, fastest way to finance a car. This type of loan is often secured, more often has a fixed rather than a variable interest rate, and you'll likely need a good credit score to apply.
- Hire purchase. Think of this loan as a rent-to-own deal. A lender purchases a car with their own money, then lends it out to another person for a fixed monthly fee including interest. Once the borrower accomplishes all their monthly repayments, the car is theirs. This car loan is often more flexible than a standard loan, and allows room for prepayments and balloon payments.
- Finance lease. Similar to commercial hire purchase, finance leasing occurs when a lender (or a lessor) allows another person (a lessee) to use their car for an agreed fixed monthly rate and leasing period. Unlike hire purchase, at the end of the contract, the lessee can decide whether they want to buy the car from the lessor or start a new lease with another car. This type of agreement is often made by businesses in need of a company car or a fleet.
- Operating lease. Just like a finance lease, a lessor lends out their car to a lessee for a set of agreed monthly repayments. However, an operating lease is more like renting a car. Once the term is over, the lessee will normally return the car to the lender.
- Novated lease. This is a three-way agreement between an employer, an employee, and a lender, where the employer deducts monthly lease payments from the salary of the employee using the car, reducing their pre-tax income.
- Chattel mortgage: In a chattel mortgage, a finance company lends a person money to buy a car predominantly for business use, but also holds a mortgage over the car as a form of security. Once the loan amount is paid in full, the title of the car is transferred to the borrower. Car loan interest rates are often lower for chattel mortgages, as the lender has a security over the car.
Car loan eligibility
To be eligible for a car loan or a lease, you must be at least 18 years of age. You must also be an Australian citizen or have an acceptable residency visa. Finally, most lessors and lenders are concerned with a borrower's capacity to make their repayments, so a regular source of income is also required. The lender will also perform a hard credit check and make a decision about approval and interest rates based on your creditworthiness. It is a good idea to get your credit report before applying, giving you the chance to clean up any issues there may be before applying.
Car loan documents checklist
Once you've decided on the type of car you're going to purchase as well as the kind of loan you're willing to take, your next step is to put together the required documents. While not all lenders will require you to submit each of these documents, it doesn't hurt to be prepared.
- Proof of identity. To secure any kind of personal loan, you will need to provide 100 points of identification. Copies of your birth certificate (or Australian citizenship certificate) and your passport will get you 70 points each, while an Australian driver's licence or tertiary student card will get you 40, and a credit card or Medicare card will score 25.
- Proof of income. Payslips are the most common form of proof of income for employees. Usually, lenders ask for at least your last two payslips to verify your income and your employer. If you are a business owner or are self-employed, you can provide tax returns or financial statements.
- Proof of residence. To prove your residence, you can provide a copy of a utility bill with your name and address, a rental contract or a mortgage agreement.
- Proof of savings. Some lenders screen their borrowers based on their perceived ability to keep making their monthly repayments. Don't be surprised if a lender asks for a bank statement – and make sure you've got some money in it.
- Proof of assets and liabilities. Some lenders might ask you to make a list of your assets. These are your investments (e.g. shares), superannuation, and any property you own. They'll also want to know about your liabilities – mortgages and other loans, including credit card balances.
- Information about the car you want to buy. This may include an invoice or sale contract from the dealer, the make, model and year of the vehicle, the VIN number and registration details.
- Proof of insurance. As third party insurance is compulsory in Australia, most lenders will turn down borrowers who do not have any kind of insurance plan for their car.