A car loan is a loan or credit product that individuals use to purchase a vehicle. A lender or bank, after conducting responsible lending checks, will approve a customer for a loan. This loan is either deposited to the customer’s bank account, given to them as a cheque, or wired directly to their dealer or seller. In return for this money, the borrower must pay back the lender with interest. How long this takes can vary due to the different products on offer, interest rates, loan terms, and so on.
Variable vs fixed rate car loans
The first thing to know is that interest rates are dependent on market factors, with the most important being the Reserve Bank of Australia official cash rate. The cash rate is the “official interest rate” that banks set their interest rates to. If this goes up or down, so do interest rates for loan products such as car loans.
Fixed rate car loans are loans where the interest rate charged on the loan amount is the same or “fixed” for the entire loan term. A fixed rate loan will stay the same whether the RBA cash rate goes up or down. Most car loans are fixed rate loans.
Fixed rate loans make your car loan more reliable in terms of repayments. Your repayments will stay the same throughout the entire loan term, so there’s no surprises if the interest rate goes up or down.
Variable rate loans are as they suggest; they can go up or down depending on whether the RBA raises or lowers its official cash rate, as well as other factors that may come into play. The difference is that your repayments may go up or down depending on that rate. If you have budgeted for a five-year term at a fixed payment rate, a variable rate might better value if interest rates go down; or it might blow your budget out entirely if the opposite occurs. Be careful when looking at variable rates, as historical data may not indicate future performance of the market.
What type of car loans are available in Australia?
Unsecured personal loans
An unsecured personal loan is a loan product that enables the borrower to gain a lump sum of money to spend it on a large purchase. There is no security or asset tied to the loan. As a result, these loans carry a higher than usual interest rate.
Secured car loans
The most common type of car loan, a secured car loan is a loan specifically granted to an individual or dealer directly to pay for a car and take ownership immediately. These are secured or backed by the asset being purchased. Since it is backed by a security, interest rates are usually significantly lower compared with unsecured car loans.
Chattel mortgage and hire purchase
These loans are for business customers who use a car for business purposes 50% or more of the time. Like secured car loans, business takes out a loan and pays the car off over time. Hire purchases are functionally the same, but car ownership rests with the bank or lender during the loan term instead.
This is an agreement between an employee, their employer, and a car dealer. An employee sacrifices some of their salary to go toward a new car, which they take ownership of straight away. This has the effect of reducing their take home pay which can reduce their tax obligations as they pay the car off.