How do car loans work?

Buying a car should be stress-free and exciting. We've explained how car loans work in-depth to help guide you through one of the biggest purchases in life.

Couple looking at new car at dealership

A car loan is a personal loan which has been specifically designed for the purchase of new or used cars.

When you take out a car loan you will have to agree to repay the loan in a certain amount of time – this is known as a loan term, and is agreed when you apply for the car loan. Aside from buying property, a car is one of the biggest purchases you will likely ever make, so it’s important to understand your options when it comes to finance. If you don’t have enough spare cash to purchase a car, you can apply for a car loan.

As you are borrowing money when you take out a car loan, you will normally need to sign a credit contract. It is important you understand the credit contract, including details such as the amount borrowed, term, and any fees and charges associated with the loan.

Car Loan Features

Car loans are normally secured against your vehicle

Usually, car loans are secured against the vehicle you are purchasing. This gives your lender added ‘assurance’ so that if you were to ever be unable to repay your loan, there is an asset that could be sold to repay the funds. For this reason, secured car loans usually have a lower interest rate than a standard unsecured personal loan. If your vehicle is being added as security for the loan, it will usually have to meet certain roadworthy criteria and be comprehensively insured.  

Car loans can be used for new or second hand vehicles

A car loan can usually be used to purchase a new or second hand vehicle. The age of a second hand vehicle might determine the type of car loan you take out.

For example, the Heritage Car Loan is great for new or second hand vehicles up to 7 years of age. However, if the vehicle you are looking at purchasing is over 7 years of age you will have to apply for our Personal Loan. 

If your car loan is a fixed rate, you’ll be certain of your repayments

By taking out a fixed rate car loan you can be certain of what your repayments will be. This can help you budget accordingly and will save you from worrying about what changes in the interest rate will mean for your monthly spending.

Seek pre-approval before you shop

Obtaining loan pre-approval can be beneficial before you start to shop. You'll know how much you can afford to spend, and it might help to reduce the pressure of taking out finance with a non-bank lender. You can quick start your car loan application online with Heritage today. 

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Choosing a car loan

It pays to do your research on your choice of car loan provider. Using a tool like Money Smart’s Personal Loan Calculator can allow you to compare the cost of the loans you’re considering, including interest rate and fees. Here's some other things to consider: 

Interest Rate

While the lowest interest rate may be the most appealing, it’s important to think about the features and benefits that you’ll be getting as well. One lender may offer you a lower interest rate but won’t allow you to make extra repayments. Another may have a higher interest rate, but give you flexibility to pay your loan off sooner.  It is also important to think about the impact that fees may also have on overall cost. 

Introductory Interest Rates or Balloon Payment

Be careful that the car loan you are signing up for is not advertising an ‘introductory rate’. This could mean you’ll end up paying a high interest rate after a specified period of time. 

Car loans with lease deals or balloon payments are a bit different to. You might pay a low ongoing rate over a specified amount of time, but there will be a balloon payment at the end. Usually this is because the lender assumes you’ll be selling the car. However if the selling price of your car is less than your balloon payment you might be out of pocket.

Loan Term

It isn’t usually top of mind when taking out a car loan, but choosing a loan term that suits you is important. A shorter loan term means your loan gets paid out faster and it can reduce the amount of interest you pay.

A longer loan term may suit your budget better with reduced repayments. It can also increase the amount of interest you pay as you’re borrowing money for a longer period of time. If you’re unsure, your lender can help you work out which loan term suits best. 

Monthly Administration & Other Fees

Along with an application fee, some lenders may charge you a monthly administration fee. The cost of this is included in your monthly repayment. This means that a percentage of your regular repayment will go to paying a fee and interest costs before reducing the amount you owe on the loan.   It is also important to consider the impact that any other fees may have on cost

Exit fees

If you’re planning to pay your loan out early, or sell your car before your standard loan term is up, it’s important to ask about any break fees or loan finalisation fees you may have to pay. At Heritage, we allow you to repay any of our Personal Loans or Car Loans  in full at any time and we do not charge a loan finalisation fee. Other lenders may be different and break fees may be a fixed cost or reduce over the term of your loan. 

Shopping for a new car can be fun and exciting. However, it’s important to understand the ins and outs of borrowing money to finance a car. Use our car loan calculator to get a better idea of the overall cost of running a car, and check out our tips to help improve the likelihood of your loan application being approved.

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