Car loan basics – what they are and how they work

12 December 2016

Car loan basics – what they are and how they work

car loan basics aa finance

It might seem an obvious question, but what is a car loan? Of course it’s a loan to buy a car, but why not buy a car with a personal loan? Why not buy a car with a credit card or top up your mortgage? Let’s take a closer look at what a car loan is, how it works, and why it can be the smart way to borrow money for your next car purchase.

What is a car loan?

A car loan is a finance facility specifically designed to provide funding for the purchase of a vehicle. Although usually called a car loan, it can actually also be used to purchase a range of vehicles from boats to motorbikes and everything in between.

When buying a vehicle, the borrower usually pays a deposit against the cost of the vehicle, and then pays the remainder using a car loan. Interest rates are usually comparable with personal loans, higher than home loans and lower than credit cards (when compared with standard interest rates rather than balance transfers or low interest cards).

Car loans are usually secured against the vehicle being purchased. That means that if you fail to keep your end of the bargain and don’t repay the car loan as asked, the finance company can take your vehicle from you and sell it in order to get their money back. Having the vehicle as security allows finance providers to offer more competitive interest rates.

A car loan is a good way to finance a car purchase because it involves a fixed term and a set repayment structure. Unlike borrowing on a credit card, this way means even those less disciplined with their money should be able to manage repayment within a set period rather than the debt going on and on and on.

Why use a car loan?

If you’re buying a vehicle it really makes sense to use a car loan. There are other finance products that can be adapted to meet your needs, but because a car loan has been designed and structured for this purchase, it’s likely to be the best option.

Why not buy with a credit card?

Low interest credit cards can be a tempting alternative to taking out a car loan. Unfortunately because they have no set repayment structure, this can be a challenging way of repaying your debt - even if in the short term it seems like a cost effective way to set it up. The long and short of it is that unless you’re really disciplined, you’re better to opt for structured repayments and a car loan.

Why not buy a car with your home loan?

It is possible to buy a car on your home loan, especially if you have a revolving line of credit. The challenge with managing your vehicle purchase this way is that the rate at which you pay off a home loan can be considerably slower than the rate you pay off a car loan. That’s due to the overall amount of interest that gets charged, and the rate you pay back the principle on your loan.

Because of the duration of the loan, putting your car on the house can end up much more expensive in the long term, even though the interest rate may seem lower today. It’s important to understand the impact of your decision in terms of total interest cost for the life of the loan. Try out our repayment calculator here to get an indication of payments.

How do you apply for a car loan?

If you want to apply for a car loan in order to buy a vehicle, there are a few things you’re going to need to have in place. You will need to be able to meet the repayment requirements for the loan, and have a good debt-to-income ratio. That means you need to have a clear budget in place that captures both your income and expenses, and shows you have enough money left over to pay off your loan.

Your credit record will be reviewed to check that you haven’t had any issues paying off debt in the past. A poor credit record doesn’t necessarily mean you can’t borrow money; it just means the finance company will want to understand more details about your situation.

The company you choose to get your car loan with will probably also want to understand some details about the car you’re planning to buy. The car you buy is used as security against your loan, so it’s important to understand its value, condition and age.

Keen to find out more?

If you’re interested in exploring your car loan options, then contact AA Finance today on 0800 500 555. Our team will be happy to help you to find a car loan that meets your borrowing needs and matches your repayment budget.

Apply online

Disclaimer: Please note that the content provided in this article is intended as an overview and as general information only. While care is taken to ensure the content is correct, the information provided is subject to continuous change. Please use your discretion and seek independent guidance before making any decisions based on the information provided in this article.

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