What you should know about car loans

Introduction to car loans

A car loan is a personal loan specifically used to purchase a car.

Many lenders have eligibility criteria attached to the car loans they offer such as whether the car is new or used, the age of the car, purchase price, or whether you purchased the car from a dealership or through a private sale. This means it is important to do your research and find a loan that fits your situation.

Many car loans are priced on risk, which means that you are likely to pay a higher interest rate if you are perceived to be a higher risk applicant by the lender. Similarly, for a lower risk customer the interest rate is likely to be lower.

Are you loan ready? Check your credit score and credit file information before you apply for a car loan to ensure that everything is up to date and error-free and you know where you stand when it comes to negotiating with the dealer.

Before you sign your credit contract, make sure you read the entire contract carefully and double check all the details and fine print.

Secured car loan

A secured car loan requires you to offer up an asset as security to the lender. In most cases, the security is the car.

In the event that you fail to repay your loan, the lender can repossess your car and sell it to recover their money. If the resale value of the car does not pay off the full amount outstanding, you will still have to repay the lender the remaining amount.

Lenders usually require you to take out comprehensive insurance on the car used as security.

Unsecured car loan

An unsecured car loan does not require you to offer up any security to the lender. This is more common for loans to purchase older used cars because the car has a lower resale value.

You need to convince the lender of your credit worthiness and demonstrate you are in a good financial position to repay the loan. The lender is taking on more risk and will usually charge a higher interest rate.

If you fail to make your repayments, your lender has the right to take legal action against you to recover their money.

Other types of car financing

Specialist financing

Car financing is also available from non-traditional lenders such as specialist finance companies. Specialist financiers can arrange car loans, but may also offer car leases, hire purchase agreements, and lending in other areas such as equipment finance or business finance.

Before entering into any agreement, make sure you know all the details of the contract including the interest rate charged, the fees payable, how repayments are made, and any additional terms and conditions.

For example, check with the lender if there is a balloon payment at the end of the loan term. A balloon payment is a lump sum payable at the end of the loan, making your regular repayments seem cheaper.

Dealer financing

If you purchase a car from a dealer, they may offer to arrange financing for you.

Although it is convenient to arrange everything in one place, it is important to remember that many dealers receive a commission from the finance company when offering you finance, so they may try to sell you additional add-ons that you don't need. It also important to check the interest rate on the loan so you can compare it with loans from other providers.

Discuss with the dealer if there is any room to negotiate the terms of the financing and make sure that it is available on the brand and model of car you intend to purchase

Fixed or variable car loan?

Majority of car loans charge a fixed interest rate, however, there are some in the market that are variable.

The repayments on a fixed car loan do not change for the entire term of your loan, even if interest rates fluctuate. Fixed repayments are easier to budget for each month, however, many lenders charge you a fee if you want to make extra repayments and repay your loan early.

The repayments on a variable car loan may change from time to time if interest rates change. Variable car loans generally allow you to make extra repayments and repay your loan early without penalties, however, it is harder to budget for repayments that may change month to month.

Fees

Establishment fees

Your lender may charge you a one-off application or establishment fee when you accept your loan. This fee covers the cost of arranging and administering your loan.

Ongoing fees

Your lender may charge you regular ongoing, service, or administration fees to cover the cost of maintaining your loan. These fees are usually charged monthly, quarterly, or yearly.

Early exit fees

Some lenders charge you an early exit fee if you repay part or all of your loan before the end of the loan term. If you plan on making extra repayments, check how much your lender will charge you to make sure it doesn't cancel out the benefits of early repayment.