Car Loan

Daniel Brown

Financial ExpertUpdated on May 4, 2022

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For someone earning an average income, the cost of a vehicle may be beyond their means. If you are in the same situation, you may have to consider applying for a car loan. The question is, will your application be approved? 

To make a car loan work to your advantage, you need to understand the application process. You should also evaluate the benefits, weigh up the risks, and consider other essential factors like interest rates. 

This article discusses these topics and addresses fundamental questions that potential borrowers and car loan applicants need to keep in mind. 

Erik Mclean | Unplash

What Is a Car Loan?

A car loan is a sum of money that’s borrowed from a bank or a lender to purchase a vehicle. The borrower can be a person, business, or any other entity. 

A legal agreement is made between the lender and borrower for this purpose. The borrower agrees to pay back the amount of the loan and any corresponding interests. Typically, payments are staggered every month.

How Do Car Loans Work?

Car loans work the same way as home loans do. You purchase a vehicle through a financial institution, like a bank or an auto dealer, and the lender agrees to loan a sum of money. Meanwhile, the borrower agrees to pay back the amount through monthly repayment options with interests. 

Suppose the payment is not made according to the agreement. In that case, there may be corresponding penalties depending on the terms and conditions of the contract. The lender may also have the right to take possession of the car. 

Who Can Get a Car Loan?

The minimum eligibility requirements for car loans in Australia include official citizenship, or permanent residency. Applicants should also be above 18 years of age and earning income. However, the vehicle finance criteria may vary among lending institutions. 

Generally, the evaluation for eligibility is based on the following factors:

  • Borrower’s income
  • Credit rating and history
  • Assets and liabilities
  • History of savings
  • Type of car that you choose 

Anyone can apply for a car loan, but the grant would depend on the specific requirements set by the bank or lending company. It’s essential to know these criteria first before applying. 

How to Apply for a Car Loan? 

Some car applications are approved within a day, especially if the borrower meets the criteria and submits complete documents. The most common documents financial institutions require include the following: 

  • Bank statements for three months
  • Tax returns for two years 
  • Income statement from the employer
  • Driver’s license
  • Passport 
  • Proof of monthly expenses
  • Amount of credit available 

Your car loan application will most likely be approved if you have an excellent financial status and a complete set of requirements.

How Much Can I Borrow with a Car Loan? 

You can choose the amount of money you want to borrow from a bank. However, the lender would first assess whether that sum could be granted based on their lending criteria.

 Generally, financial institutions evaluate the following factors when deciding how much an individual can borrow: 

  • Credit score
  • Yearly income
  • Amount of savings
  • Regular living expenses
  • Other personal loans

Types of Car Loans

Depending on your personal preferences and financial situation, you can choose from these types of car loans in Australia: 

  •   Standard Loan From a Bank or Credit Union 

This type of loan involves a borrower and a lender who loans a specific amount to allow the purchase of a new or used vehicle, depending on certain conditions.

The benefits of this type of car loan include agreed monthly repayments over a specified period. Financing may cover on-road costs and low variable or fixed interest rates because finance is secured against the vehicle you wish to purchase. 

This option also includes flexible terms for the duration or life of the loan and repayments.  

  • Finance Lease 

A finance lease involves a financier who buys the car and then offers it for lease to the borrower. This type of car loan provides immediate use of the vehicle with little or no capital outlay.

The agreements between the two parties commonly include repayment frequency where the borrower is responsible for the car’s maintenance and trade-in residual risk.  

At the end of the lease period, the borrower can refinance, return, sell, or buy the car for the residual amount. This option can be advantageous to individuals wanting lease payments made from pre-tax dollars. The interest rate is also fixed and low, and the repayments are typically tax-deductible. 

  • Commercial Hire Purchase 

The lender buys the vehicle and the client then hires it over a certain period. Once all loan repayments for the cost of the loan have been made, as specified in the agreement, the car is transferred to the borrower. 

This car loan allows flexible financing of the total purchase price, a deposit or trade-in, or a lump sum balloon payment. It also has fixed interest rates in repayments and low capital outlay, which are adjusted to suit the borrower’s budget. 

  • Operating Lease

A financier purchases the car and rents it out to a borrower based on the agreed-upon terms and conditions. The financier retains the ownership. Therefore, the borrower shoulders no risk associated with ownership and the residual value at the completion period. 

The borrower is given the option to buy the car, continue renting it, or change to another unit at the end of the operating lease period. This type of car loan has some benefits, such as fixed car loan repayments over a specified period. Rent is also tax-deductible and the lease does not affect debt ratios. 

  • Chattel Mortgage 

This is a fixed loan where the lender gives the money in advance to buy the car. The financier holds a mortgage over the vehicle, which is considered a security for the loan. 

The borrower can purchase the car in cash, make a deposit, or a trade-in depending on their personal preference. A residual payment may be required at the end of the term.

Advantages of this car loan option include ownership of the car at the time of purchase, flexible contract terms, minimal capital outlay, fixed repayments, and lower interest rates. Moreover, interest and depreciation are tax-deductible. 

  • Novated Lease

This is a three-way agreement where the borrower’s wage is reduced, which is called salary sacrifice, in exchange for an equal value of the car benefits. The borrower leases the vehicle from the financier through a novated deed on the income. 

Other costs such as insurance fees, vehicle registration, and servicing are covered by the borrower. The benefits of this car loan type include payment of the vehicle through salary sacrifice. The car may also be leased for private use and bought at the end of the lease. 

Benefits of a Car Loan

A car loan can provide benefits, which you may not receive if you choose to pay outright. Other advantages for borrowers include: 

  • Purchase a Car Upon Approval of Loan

You will have a new car once the financing company grants your loan. This can be advantageous on your part if you do not have sufficient cash.  

Some lending companies provide 100% financing. This provision can guarantee immediate possession of a car under your name. 

  • Credit History

Car loans allow you to build and improve your credit history. That means your credit score will continue to increase as long as you settle your repayments. 

Building a good credit history can help with future financing requirements for other types of loans. 

  • Low Rates

Generally, secured car loans are offered at lower interest rates than unsecured loans. For example, a typical five-year term might only accrue a few thousand dollars in interest. 

The amount of your loan and the price of the car can affect the loan interest rates. 

  • Tax Deductions

Suppose you buy a car for business purposes. In that case, the interest payable and the running costs of the vehicle can be tax-deductible. The amount of tax claim would depend on the business use percentage. 

  • Establish a Good Credit Score

Car dealers must have an Australian Credit Licence as a legal requirement for selling or leasing cars. If you purchase a used car from a car dealership, you are protected by the law. Your payments could also help build a good credit score. 

Disadvantages of a Car Loan

  • Interest and fees

Getting a car loan involves paying a reasonable car loan interest rate and monthly fees for the transaction. If you pay the vehicle outright with cash, you do not have to pay for additional charges or extra repayments. 

  • Bank Retains Car Ownership

The bank has the right to take possession of the car if there’s failure on the borrower’s part to make repayments of the loan. If this happens, you might have a bad credit history. 

  • Depreciation

While you are still paying for a car loan, the value of your car can already be depreciating. The rate of depreciation depends on the type of car you purchased. 

It can be disadvantageous in the sense that the amount owed to the bank may be greater than the market value of the car, even before the loan term ends. 

How to Compare Car Loans

As a borrower, you can decide which car loan you would like to choose. You can only do this properly by carefully evaluating your choices. 

You have to consider specific criteria that can guide you in making the right decision. The following factors have to be take into account accordingly: 

  • Processing Fees

The bank where you apply for a car loan would charge you processing or application fees. These amounts may vary and can be higher or lower depending on the bank. 

To know whether you will get a reasonable rate of processing or establishment fees, you must research the costs that your prospective banks require before processing the loan. 

  • Interest Rate

Interest rates should be the main priority when comparing car loans or loan products. They will determine how much you will pay for monthly installments either through a bank account or other means. 

These rates also influence the total cost of the car when the loan is paid in full and when penalties are incurred. 

Therefore, the lower the interest rate, the more advantageous a new car loan would be for you. Keep in mind that some banks include the customer’s background when determining the interest rate to impose. For example, your income and the other loans you have taken can affect the interest rate. 

  • Equated Monthly Installment

The equated monthly installment refers to the amount that you have to pay each month for the repayment of your loan. The EMI depends on the tenure of your car loan and the interest rates. 

Therefore, the longer the duration of the loan, the lower the monthly instalment; however, the interest rates may be higher in this case. 

As a piece of financial advice, choose a car loan with tenure that allows you to pay the EMI within your financial capacity. It would significantly help with your finances if you do not make the payment terms too long.

Longer terms could also mean additional repayments in the long run. 

  • Loan to Down Payment Value

Another important factor when comparing car loans is the percentage of the vehicle’s cost that the bank can provide as a loan. You have to know whether this amount can enable you to buy the car of your choice.

The vehicle cost will also help determine the amount of down payment for the car purchase. Some banks may charge the borrower a percentage of the car’s value before granting the car loan or financial product.   

  • Processing Time

If you are an individual who always has a full schedule, then time is valuable to you. So the processing time of your car loan is another factor for you to consider. 

Check your available finance options to determine how quickly you can obtain a car loan from your chosen banks. 

  • Prepayment of Foreclosure Charges

If you decide to pay the car loan before its maturity, what would be the financial implications? Will you be able to reduce the cost for prepayment? Typically, borrowers can save on interest payments from early repayment fees. 

However, you have to be aware of the terms and conditions of your car loan. If the bank allows prepayment, which is usually the case, you can consider paying in advance. 

Fixed or Variable Interest Rate?

Fixed Interest Rate Loans

These are loans in which the interest rate is fixed for the entire term, regardless of the market interest rates. Therefore, the payment for the fixed-rate car loan is the same for the entirety of its duration. 

This does not necessarily mean that this type is the right loan for you. It would still depend on the interest rate environment when the loan is taken, as well as the terms you choose. 

Generally, if the interest rates are low, but are likely to increase, it would be favourable to get a loan with a fixed rate. 

Variable Interest Rate Loans

The interest rates of this loan option are charged on the outstanding balance, which varies as market interest rates change. They are also assessed on a variable interest linked to an underlying index or benchmark, such as the federal funds rate. 

This system results in varied payments, as long as they are blended with principal and interest. You can get variable interest rates from personal loans, mortgages, credit cards, corporate bonds, and derivatives. 

Fixed Interest Rate and Variable Interest Rate: Which Is Better?

Based on relevant studies, borrowers are more likely to pay lower interest rates with a variable rate loan than fixed-rate loans. However, the trends are not necessarily indicative of future performance.

Other factors such as the amortization period of a loan are also essential to know which is more advantageous for the borrower. The longer the given amortization period, the higher the impact of a change in interest rates on the loan payments. 

Balloon Payments

These are hefty payment fees at the end of a balloon loan, such as a commercial loan, mortgage, or another kind of amortized loan. This payment works similarly with bullet repayment –a lump sum payment for the total of an outstanding loan amount, usually during maturity. 

Meanwhile, a balloon loan is given for a short term. Only a portion of the loan’s principal balance is amortized in the agreed period. The remaining balance is due as final payment at the end of the loan term. 

Balloon payments are usually not less than twice the amount of the loan’s previous payments. These payment terms are more common in commercial lending than in consumer lending because the average borrower cannot get a large balloon payment at the end of the mortgage. 

In a balloon payment mortgage, the borrower pays a set interest rate for a given number of years. The loan then resets and the balloon payment rolls into a continuing or new amortized mortgage at the end of the loan duration. This mortgage is based on the prevailing market rates.  

Average Interest Rate on a Car Loan

The monthly payment for a car loan would depend on several factors such as the vehicle price, down payment, duration of the loan term, interest rate, and credit scores. Keep in mind that the interest rates on used car loans tend to be higher than those on new vehicle loans. 

There are now online car loan calculators that you can use for different comparison rates. These tools can be found on lending companies’ websites. 

You only need to input details such as vehicle cost, terms of the loan, newness of the car (new or used?), and interest rates. Then you can find out how much you can borrow, the required down payment, monthly instalment fees, and any interest rates. 

Annual Percentage Rate for a Car Loan 

The APR (annual percentage rate) pertains to the annual rate of interest charged to borrowers and paid to investors. It is expressed as a percentage that represents the actual yearly cost of funds over the term of a loan. 

You can make use of APR to compare rates of lenders for a car loan as it provides a bottom-line figure. The ideal APR for borrowers depends on several factors, such as the prime interest rate set by the central bank, competing rates in the market, and your credit score. 

When the prime rates are low, the lenders may offer low APRs on credit products, like car loans or lease options. However, you still need to verify whether these rates would last for the full length of the loan term or if they are just introductory rates that could revert to higher APR after a certain period. 

Low APRs may only be available to clients with high credit scores.

What Is the Best Car Loan in Australia? 

Borrowing money to buy a car is a critical decision. Therefore, you must know which bank can offer the best terms and conditions for a car loan.

Low interest rates and guaranteed long-term advantages are excellent signifiers that you are working with a good finance agent or company. 

When choosing a car loan in Australia, it is recommended to focus on the following factors: 

  1. Check whether your depreciation is a tax deduction
  2. Find reasonable interest rates
  3. Consider after-factory extras 
  4. Secure a good car insurance policy
  5. Avoid balloon payments

FAQs

  1. Can I still get a car loan if I am self-employed? 

Yes. You have to decide whether to apply as an individual or on behalf of your business before taking steps in processing a car loan. 

If you apply as an individual, it’s a requirement that you provide proof of income, such as a bank statement. 

If you apply through your business, you will need an Australian business number (ABN), a declaration of individual tax returns for sole traders, company tax returns for the last two years, and financial statements. As a general rule, your net profit must be twice the loan you wish to get. 

  1. Can I get a car loan without a licence? 

It depends on which Australian state you are applying for a car loan in.   The requirements set by the bank or lending company may also vary from state to state. 

For example, you can get a car loan and register a vehicle without a driver’s licence in Victoria and New South Wales. But in South Australia, you cannot register a vehicle without a licence. 

  1. How do I spot a car loan trap? 

You need to be careful of car loan traps that might cause problems, especially if you are a first-time borrower. 

Car loan traps usually include the following: 

– Packing payments where the dealers get buyers to agree to an inflated monthly payment

– Letting the dealer mark up the interest rate

– Paying bogus fees

– Loan extensions

– Buying overpriced extras 

Always check the product disclosure statement, the fine print, or any disclaimers before getting a car loan.

Need professional help with your car loan application? Request a call from our expert finance agent today! 

 References

  1. Investopedia, Fixed and Variable Rate Loans: Which is Better? Retrieved from https://www.investopedia.com/ask/answers/07/fixed-variable.asp 
  2. Investopedia, Balloon Payment, retrieved from https://www.investopedia.com/terms/b/balloon-payment.asp 
  3. Investopedia, Auto Loan Calculator, retrieved from https://www.investopedia.com/car-loan-calculator-5084761 
  4. Investopedia, Annual Percentage Rate (APR), retrieved from https://www.investopedia.com/terms/a/apr.asp 

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Disclaimers

This is a model, not a prediction. Amounts and repayment periods are estimates only, actual amounts may be higher or lower.

  • It applies to loans where your regular repayment includes both interest and the gradual repayment of the amount borrowed.
  • Initial inputs will be displayed on the left hand side of the graph. Your ‘What if’ scenario (if applicable) will be
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Disclaimers

This is a model, not a prediction. Amounts and repayment periods are estimates only, actual amounts may be higher or lower.

  • It applies to loans where your regular repayment includes both interest and the gradual repayment of the amount borrowed.
  • Initial inputs will be displayed on the left hand side of the graph. Your ‘What if’ scenario (if applicable) will be
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Disclaimers

Disclaimers

This is a model, not a prediction. Amounts and repayment periods are estimates only, actual amounts may be higher or lower.

  • It applies to loans where your regular repayment includes both interest and the gradual repayment of the amount borrowed.
  • Initial inputs will be displayed on the left hand side of the graph. Your ‘What if’ scenario (if applicable) will be
    displayed on the right hand side of the graph.

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Disclaimers

Disclaimers

This is a model, not a prediction. Amounts and repayment periods are estimates only, actual amounts may be higher or lower.

  • It applies to loans where your regular repayment includes both interest and the gradual repayment of the amount borrowed.
  • Initial inputs will be displayed on the left hand side of the graph. Your ‘What if’ scenario (if applicable) will be
    displayed on the right hand side of the graph.

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Disclaimers

Disclaimers

This is a model, not a prediction. Amounts and repayment periods are estimates only, actual amounts may be higher or lower.

  • It applies to loans where your regular repayment includes both interest and the gradual repayment of the amount borrowed.
  • Initial inputs will be displayed on the left hand side of the graph. Your ‘What if’ scenario (if applicable) will be
    displayed on the right hand side of the graph.

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Disclaimers

Disclaimers

This is a model, not a prediction. Amounts and repayment periods are estimates only, actual amounts may be higher or lower.

  • It applies to loans where your regular repayment includes both interest and the gradual repayment of the amount borrowed.
  • Initial inputs will be displayed on the left hand side of the graph. Your ‘What if’ scenario (if applicable) will be
    displayed on the right hand side of the graph.