It’s too bad maths in high school focused on calculus and not real life stuff like taxes, home loans and yes, car loans. With a car loan, it’s important to understand what you’re actually paying for, what the interest rate means and how much you can afford to borrow. If you apply for a loan, the lender will likely tell you that last bit, but you don’t want to go in swinging blindly.

How does car finance work?

There’s a few key ingredients that make up a car loan. If you know how mortgages work, then it’s fairly similar, with a few key differences.

Secured vs unsecured

You’ve probably seen the ‘secured’ nametag, but what do they mean? Secured basically means the car is the collateral. If you fail to repay the loan, the lender takes your car away. As a trade-off, you likely see a lower interest rate.

Unsecured is basically the exact opposite, and are also called personal loans. Unsecured loans don’t use the car as collateral. If you fail to pay, they don’t come after the car, but may come after you in other ways. As a trade off, you’ll likely face a much higher interest rate. Be wary of lenders offering ‘car loans’ that are in fact just personal unsecured loans in disguise - you can usually tell by the higher interest rate and in the terms and conditions.

Advertised vs comparison rates

We all love a low interest rate, but what the advertised rate doesn’t consider is extra fees. This is where the comparison rate comes in - it’s basically a simple rate that is calculated based off the interest rate plus any fees. Lenders may charge a yearly or monthly account keeping fee, a loan establishment fee and more.

Fixed vs variable rates

Again, similar to mortgages you can usually choose between a fixed or variable rate. The decision is largely personal, but here’s a few considerations:

Fixed: You have a steady payment for a set term, so you know what you’ll pay every week, month or fortnight. As a trade-off, the rate could look uncompetitive if interest rates more broadly drop. If you exit a fixed loan term early you’ll likely be subject to an early exit fee, which can be steep.

Variable: In this low interest environment, a variable rate might look good now, but be aware it can change. If interest rates go up, then your variable rate will probably go up to compensate. It also means you can’t always predict what you’ll be paying every week, fortnight or month, making budgeting a little harder.

Balloon payment

A way to reduce the size of your regular car loan repayment is by adding a balloon payment at the end of your term. A balloon payment is a lump sum you owe to the financial institution at the end of the loan term. Many lenders offer balloon payments, sometimes up to 30% of the car’s value. While this can help keep your repayments low, keep in mind you’ll have to pay this out at the end.

Your car loan term

Car loans are commonly five years these days, but you also often have the choice of a three or seven year term. With a three year term, your repayments are higher, but the term is shorter, which results in less interest paid. A seven year term’s repayments may look more enticing but you ultimately pay more in interest. A five year term might strike the ‘sweet spot’ between a budget-friendly repayment and an appropriate amount of interest.

How to save money on a car loan

There’s a few tips on how you can save money on your next car loan:

Deposit

Like a house, a larger deposit can also reduce interest paid. While car loans don’t often require a deposit, it can certainly help. Even a 10-20% deposit can reduce total interest paid in the long run.

Balloon payment

As mentioned before, a balloon payment comes at the end of your loan term. In many ways, if you think about it, it’s like a deposit in reverse.

Extra payments

Not all lenders allow for this, but if yours does, paying extra into the car loan when you can budget it can keep you ahead and reduce payments later. Keeping on top of your loan can also prevent your car falling into negative equity - a situation where if you crash your car, you don’t owe more on the car than your insurer pays out.

Improving your credit score

While there are car loans out there catering towards people with low credit scores, keep in mind they may attract steep interest rates. You can improve your credit score through paying off debt on time and not falling behind. Even simpler things like a postpaid phone plan and your electricity bill can help improve your credit score.

As part of comprehensive credit reporting, some items on your credit file can stay valid for up to five years. For example, if you’ve missed a repayment, a new lender will be able to see that on your file for two years. This is one of the key areas lenders look at to determine what interest rate to charge you.

Note that applying for and being knocked back for credit can also impact your credit score. There are also a few providers out there that offer a free credit check once per year - there you can see your profile in all its glory. This is also a good time to check everything is correct, as sometimes things are reported incorrectly and it can impact your score.

If you’re ready to apply for a car loan, use our free quote form to find the right loan and repayment for you.