What Types of Car Loans Are There?
Car loans in Australia can take a variety of forms, but the most common type is a personal loan issued by a bank or finance company. All personal loans in Australia are governed by the National Consumer Credit Protection legislation which protects consumers from being granted loans that are unsuitable for them or which they cannot afford.
This legislation is relatively new in Australia, having only commenced on 1 July 2010 and whilst some of the details are uncertain and untested in the courts, it is clear that the intention is to protect consumers from obtaining credit which places them in financial jeopardy or makes it difficult for them to manage the repayments.
Despite this legislation however car loans are just another form of personal loan and are normally take two forms.
Secured loans. A secured personal or car loan is one where the lender takes a mortgage over the vehicle so that it can be sold by the lender in the event that the borrower is unable to meet repayments. Because of this security, a lender is usually prepared to offer a lower rate of interest because of the reduced risk. This does not mean that the lender is not obligated to investigate the application completely, it simply means that the bank assumes less risk and prices the loan accordingly.
Unsecured loans. In some cases, a lender might be prepared to advance funds to purchase a car without taking a mortgage over the vehicle. This would happen where the applicant has a strong asset position and a high enough income to give the lender some comfort knowing that the loan repayments are not going to cause any hardship whatsoever. The bank will still be likely to charge a higher rate of interest nevertheless because the risk is judged slightly higher.
In both of the above cases it should be remembered that the bank is still obligated to meet the requirements of government legislation and will have to ensure that an applicant is easily able to afford the repayments without suffering financial hardship.
There is another way that a car purchase can be financed, and that is via an existing home loan. If a borrower has sufficient equity in their home they can apply for an addition to their loan so they can purchase the car outright. The advantage in this approach is that home loan interest rates are generally several percentage points cheaper than a personal loan. In some cases the difference can be 5% or 6%.
For example, a personal loan of $40,000 over a seven-year term at 12.5% would require repayments of $716.85 a month. A home loan for the same amount over a 30 year period at 7% interest would require a monthly repayment of $266.12.
This does not mean that home loans are necessarily cheaper because they are taken out over a 30 year period as opposed to a seven-year period for a personal loan. You need to carefully weigh up the differences between car finance options and obtain financial advice before deciding which car finance structure is best for you.