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4 essential car loan questions to ask yourself before applying

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From Ferraris to four-wheel drives, every car buyer has probably spent at least one afternoon scrolling through car sale sites and daydreaming about their sweet new ride. But chances are, far fewer of us have pondered over how to finance the car.

While paying with cash sounds good in theory, the reality is most people can’t afford such an expensive purchase upfront. That’s why car loans are a nifty funding option to keep in mind when searching for your next set of wheels, whether it be a new or used car.

Since car loans involve borrowing a lump sum with interest charged on top, it’s important to think carefully through this money decision. The golden rule to any financial purchase is to shop around for the best deal. By comparing features like interest rates, fees and other bells and whistles (such as the ability to make extra repayments), you’ll be one step closer to finding the right loan for you.

THE BIG QUESTIONS

Should I borrow from a car dealer or a bank?

Dealer finance is often advertised as a one-stop shop for all your car needs – the vehicle and the loan sold together as a package deal. And when the dealer’s also offering an ultra-low rate or large cash back rebates, it can seem like too good of an offer to reject.

But there’s a catch: you’ll leave yourself little room to negotiate on the actual car, like the price or extra features such as window tinting and wheel insurance. So to boost your bargaining power, sort out your car loan with a bank, credit union or online lender before you’ve even walked into the dealership.

What’s my credit score?

Think of your credit score as a window into your money habits. It sums up your financial reliability and tells the lender what you’re like when it comes to paying the bills or any debts. Do you always meet repayment deadlines, or have you slacked off a couple of times?

It’s information that would interest any lender assessing your car loan application since it helps them determine how much risk you would carry as a borrower. So to avoid finding out that your loan application has been rejected, fetch a copy of your credit report and check to see where your score sits.

Lenders generally reserve their most competitive rates for customers who have higher credit scores, so polish up on your credit rating before applying.

THE SPECIFICS

How much can I afford to repay?

Depending on your financial situation, different car loans may suit you better. Say, you’re on a tight budget and every dollar counts. Then fixed rate car loans could be your cup of tea since your repayments would be consistent over the life of the loan, so you’d know exactly how much leaves your bank account every month. The downside is, they don’t offer as much on the flexibility front as variable rate loans.

With variable rate car loans, you lose the stability but gain access to more repayment options. Want to clear your debt faster and save on interest? Most variable loans will let you make extra repayments, without slugging you with an early exit fee for paying off the loan early. Or if you need to ‘dip’ into those additional repayments down the track, these loans may even come with a redraw facility.

Your loan term also affects the size of your monthly repayments. Car loan terms can range from one to seven years, with longer terms offering a bit more financial relief since your repayments would be smaller. Just bear in mind you’d also be paying more in interest over the life of the loan.

Let’s do the maths! Mozo calculations reveal that if you took out a $40,000 car loan at 5.00% p.a. over seven years, your monthly repayments would sit at $565 while your total interest would be $7,490. If you picked a three-year term instead, your repayments would rise over twofold to $1,199 but you would cut down your interest costs by more than half to $3,158.

What other costs are there?

However, interest rates aren’t the only cost to consider. Pesky signup and monthly service fees can also add up and leave a dent in your bank account.

To factor in those extra fees, check the Annual Percentage Rate (APR)! This usually appears in parentheses next to the advertised rate, and it takes into account application and ongoing fees (but not late payment fees). It’s like all the puzzle pieces coming together to give you a clearer picture of the ‘true’ cost of your loan.

Your next steps

Car loans are a great avenue for funding your next set of wheels, without too much hard work involved. Just remember that while the process can seem overwhelming at first, asking yourself the right questions can help with honing in on what loan you need and want. By shopping around, improving your credit score and picking a finance option that suits your budget, you’ll be well on your way to making a car purchase you won’t regret.

About the author

Katherine O’Chee is a finance writer at mozo.com.au where she spends her days digging into banking fine print and sharing her latest money savings hacks with consumers to help them make better financial decisions.

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