How does car finance work?

Updated On February 20th, 2023By Dynamoney

A Complete Guide to Car Loan Finance

First and foremost a car loan allows you to purchase a car by borrowing a certain amount of money to do so. As with any loan, you are required to pay interest to the financial institution from which you borrowed the money.

A car loan can be a suitable option if you don’t have enough savings to buy a car upfront, but you can afford to make weekly, fortnightly or monthly instalments to repay a loan. With any car loan, you will be required to pay back the loan within a set period of time, which is referred to as the term of the loan. The term can range typically anywhere from three to five years.

The actual amount of money you borrow will be dependent on the cost of the car you are purchasing and whether you are putting a deposit payment towards the purchase price. As the borrower, generally you can choose the length of the loan.

The interest rate tied to your loan is normally based on several personal attributes such as your job and income stability, credit score, history of repaying loans and the type of car and the condition of the car you plan to purchase.

Setting a budget for your car loan

If a car loan is something you are considering, it is important to work out how much you think you can afford to borrow and repay. Our car loan calculator can help you determine how much you can borrow and what your ongoing repayments will potentially be.

Components of car loan finance

Let’s look at the multiple components of a car loan.

Loan period

This is the length of the car loan. At Dynamoney we offer car loan finance with loan periods of up to five years. The longer the period/term of the loan, the lower the weekly, fortnightly, or monthly repayments will be. But bear in mind the longer the loan period, the more interest you will pay.

Interest rates

In most cases, car financing companies offer fixed car loans, which means that the interest rate remains unchanged for the duration of the loan. When considering car loan finance be sure to shop around to ensure you are getting the best rate for your needs.

Repayments

Most car loan lenders will allow borrowers to choose to repay their car loan finance weekly, fortnightly or monthly. In most cases lenders will also allow extra repayments to be made, which can help you pay off your car loan sooner, and also means you pay less interest. The downside of paying off a loan early is potentially having to pay an early termination fee.

Late payment fees

If you miss a repayment normally you will be charged a late payment fee as a penalty. To avoid paying a late payment fee, it is a good idea to set up your repayments via direct debit, so you don’t have to constantly remember to make the payments.

Residual or balloon payments

A residual or balloon payment refers to an agreed one-off lump sum payment made at the end of your car loan. They are often used to reduce your repayment amounts.

Other car loan finance fees and charges

Some car loan financiers will charge you establishment fees, ongoing monthly account keeping fees, break fees and discharge fees. It is important to be aware of all fees and charges before signing a new car loan.

Lender

The lender is the company that provides you with a car loan to purchase a new or used car.

Where can you get a car loan from?

Dealer Finance

Dealer finance is a loan offered by the actual dealership you are purchasing from. This can be a fast, convenient way of obtaining car loan finance, as it requires no planning or research.

Depending on the brand of the vehicle, and if the dealership is offering any special offers on financing, interest rates can be higher and there may be extra fees or commissions included. Whilst dealership finance can be more convenient, it also means it is more difficult to know if you are getting the best deal available.

The dealer may also mark up the price of the car to account for the time it takes them to arrange the car loan for you, so be sure to check the details of the contract, and whether any additional fees apply.

Pros

• Fast and convenient, as you can apply for the loan and purchase the car on the same day.
• You might be able to negotiate a better deal with the dealer, as ultimately, they want your business.

Cons

• Balloon payments are often a requirement with dealer finance.
• Interest rates may be higher compared to other lending institutions.

Banks

Most banks offer a variety of car loans and vehicle financing solutions, including secured car loans, personal loans (unsecured car loans) and car leases. If you decide to use a bank for your car loan finance, it is best to obtain pre-approval for a loan before shopping for your car. That way you know your borrowing capacity upfront, and it avoids the dealer offering their financing products as well.

Pros

• There are many lenders and banks to choose from including the Big 4, customer-owned or online options.
• Often banks offer flexible unsecured and secured car loan options that in some instances may allow you to switch from variable to fixed interest rates. Some bank lenders also offer the ability to refinance to a more competitive product or change the frequency at which you make repayments.

Cons

• Sometimes banks can charge higher interest rates.
• The approval process can take longer, anywhere from a few hours to a day, or several days.
• Often there is less room for negotiation as lenders are unlikely to change the features of the loan being offered.

Non-bank lenders

Online lenders offer a range of options for car loan finance for both business and personal use. As they access their funding differently to traditional banks, in a lot of cases they can offer lower and more competitive interest rates. Non-bank lenders are also a good option for borrowers with a bad credit history or who are seeking a low doc car loan.

Pros

• Competitive interest rates. Many non-bank lenders including Dynamoney operate predominantly online. As a result, they can normally offer lower and more competitive interest rates especially for the self employed.
• Lower fees and on-going charges
• Flexible approach to lending allowing loans to be tailored to customers needs
• Faster loan applications. At Dynamoney we can approve car loan finance within as little as 3 hours
• Finance available on a wide range of makes and models including Ford, Mazda, Toyota, Hyundai, Kia, Honda, Subaru

Cons

• Most non-bank lenders are online only with no physical branches.

Types of car finance

Car loan

A car loan, also sometimes called a secured car loan, is where a borrower is lent money by a finance company to purchase a car. In this instance, the car is the security over the loan.

Unsecured car loans

Often referred to as a personal loan, an unsecured car loan is when a finance company lends a borrower money to purchase a car for personal use. As the loan is not secured, the borrower owns the vehicle from the time of purchase but must still make regular loan and interest repayments as agreed over the length of the loan period.

Chattel mortgage

The car financing company lends the borrower money to buy a vehicle that will primarily be used for business reasons. The borrower will still pay back the loan via set repayments over the life of the car loan.

In this instance whilst the borrower owns the vehicle outright, the financing company places a ‘mortgage’ over the vehicle as security for the loan. Once the loan and any balloon (residual) payments have been paid in full, the mortgage is removed.

If there is a balloon payment, the borrower can choose to refinance that amount or trade the vehicle in.

Car lease

Specifically aimed at people who will mainly be using their vehicle for business purposes, a car lease effectively works as a long-term rental. A finance company will purchase a car on your behalf and then lease it back to you for an agreed monthly fee.

When the lease ends, you will be given the option to either purchase the car by paying a final lump sum (the residual value), to restart another lease to pay off the remaining balance, or to trade the vehicle in.

Hire purchase

A commercial hire agreement is when a lender purchases a vehicle on your behalf and then you hire it back. You as the individual have full use of the car over the term of the agreement, but you don’t own the car.

Once the total price and interest have been repaid in full, ownership of the vehicle transfers to you. Hire purchase agreements are usually one to five years in length and can be a good option if you are registered for GST on a cash accounting or accruals basis, and are using the vehicle for business use.

GST is charged on the fees and interest, but not on the monthly rental or residual payment (if applicable). If you are registered for GST, you may be able to claim the GST on the car price, the fees and the interest.

Novated leasing

Novated leasing is an agreement between an employee, their employer and a car dealer. An employee sacrifices some of their salary to go toward purchasing a new car and they own the car from the beginning.

Novated leasing reduces an employee’s take-home pay, which can reduce their tax obligations as they pay the car off.

What to consider before applying for car finance

Avoid 1% or 0% interest rate deals

Car dealers that advertise ‘zero percent,’ or ‘1% percent’ finance can be very misleading. These deals often mean you end up paying a higher price for the car overall.

The terms and fine print may also include higher fees and short low-interest periods of six to twelve months, before reverting to a standard or high interest rate afterward.

Using a deposit can help to reduce your car loan repayments

If you have a deposit or car to trade in when buying a new car, this can reduce your regular repayments substantially, and improve your chances of lower interest rate approvals.

With a lesser amount of the purchase price being financed, the overall car loan itself will be cheaper. With more paid upfront, the borrower usually will have a lower risk profile which can work in your favour.

New or used

In most cases, a new car is more expensive than buying used, however, buying new could marginally improve the interest rate offered by lenders.

New cars are more valuable and generally come with fewer risks, so lenders are more willing to lend to people who intend to buy new. Weigh up what is more important before diving into the application process.

What you need to apply for a car finance

When applying for a car loan you will need to provide the following:

Identification

At least 100 points of ID will be required. This can include your driver’s licence, passport, Medicare card, etc.

Vehicle particulars

The purchase price, whether the vehicle is new or used, the make and model, engine and registration numbers.

Proof of income

You will need to provide evidence of regular payments at minimum two or three recent ones. Proof of employment and your employer’s contact details will also be needed.

Assets and liabilities

This may include details of any properties you own, any other loans you may have, your ongoing expenses and any other debts (such as credit card debts).

For a new car you will also need:

The dealer invoice and a comprehensive insurance policy.

For used cars you will also need:

Dealer invoice and or registration papers, plus a comprehensive insurance policy.

How Dynamoney Can Help

At Dynamoney, our business car loans require applicants to have a registered ABN number, be GST registered and have been trading in business for a minimum of twelve months. Self-employed applicants may need two years’ worth of tax returns.

To find out more about our car loan finance options contact one of our team members today.