Car Finance Explained

It’s a great day when you can get into your car and drive wherever you need to go, with the peace of mind that you’re covered in more ways than one. However, if buying a car stresses you out financially, there are a few things you need to know beforehand. Whether you’re upgrading to a brand-new car or looking for a reliable pre-owned vehicle, financing is the way to go when you’re budgeting for an investment, whether it’s long-term or short-term. 

This guide is designed to help you understand car finance, its terminology, as well as the type of payment plans available. 

The Ultimate Guide to Car Finance

Nowadays, a lot of people have to look into financing their vehicles as new car prices continue to inflate. And with all the information that’s available online, it can be overwhelming, especially if you’re buying a car for the first time. The goal is to not only get you a payment plan that works for you and your overall lifestyle, but to help you qualify. Getting approved will depend on how realistic you are about your budget, credit score, and how you forecast your spending.

Applying for car finance

You can choose to finance your car through your bank, credit union, or dealership, each offering distinct pros and cons. Credit unions may provide more flexible terms and lower interest rates compared to dealerships, but they often have fewer financing options. Dealerships can streamline the buying process by handling everything in-house, but they might have higher interest rates or lower approval rates, especially for those with less-than-perfect credit. Banks could offer competitive interest rates but may come with higher fees and stricter credit requirements. Ultimately, the best option depends on your financial situation and needs.

Credit score

Your credit score is what convinces the lender to give you the much-needed financial assistance to pay off your car. With that in mind, several factors are considered when you apply for car finance, such as the number of credit applications in your name, credit usage, payment history, number of accounts, court rulings, and defaults.

AutoTrader has conveniently laid out the credit score system so that you understand what lenders look for:

• A score from 300 to 580 is considered poor and unfit for car finance.
• A rating between 580 and 670 means that your application will be considered but not guaranteed.
• A score between 670 and 739 would likely qualify for approval.
• If you score between 740 and 799, your chance for approval is good, and competitive interest rate offers would be considered.
• You’re at the top of your game if you have a score between 800 and 850. Apart from approval, you’d most likely receive the best interest rates from lenders.

Types of car loans

 Instalment agreement

The bank or credit provider pays for the vehicle on behalf of the buyer who has requested the loan. This loan allows you to purchase the vehicle in equal monthly instalments (including interest) over a set period, typically ranging from 12 to 72 months, or longer in some cases. Only after the final instalment or full amount has been paid off do you become the official car owner.

Instalment and balloon payment

With the instalment and balloon payment loan you’re able to purchase a vehicle from a private seller or dealership in equal monthly instalments with the balloon payment as your final payment (this is typically a set percentage of the purchase price). Even though it reduces your monthly instalments, you’d still have to pay a lump sum at the end of the contract. The only thing to keep in mind is that you’d need to have that amount readily available when the time comes.

 Lease agreement 

A lease agreement is beneficial for: 

1. Business owners who want flexibility on upgrades, reduced maintenance costs, and budget predictability.
2. Individuals seeking to minimise car maintenance costs and other expenses
3. People who have short-term vehicle needs, i.e. flexible lifestyle
4. Anyone who cannot manage the financial strain of full car ownership. 
5. It’s an option for those are not looking to make a long-term investment.

This contract allows you to make monthly instalments on a vehicle you’ve agreed to use during the lease term. By the time you reach the end of the lease, you’ll have three options: you can buy the vehicle from the lessor, renew the agreement, or return the vehicle. The contract does come with several terms and conditions: mileage limit, condition of vehicle, term, etc. 

Be sure to review the agreement thoroughly. 

 Can I finance my car with a personal loan?

You sure can. It’s especially beneficial if you’re looking to buy a pre-owned vehicle that’s reasonably priced with no strings attached. Because it’s an unsecured loan, you don’t have to worry about lump sum payments, terms, or collateral. However, be sure to compare rates, fees, and loan conditions from all angles. For example, you could be looking at higher interest rates on a personal loan compared to a dealership-financed vehicle.

Your car, your budget

Each type of loan has its pros and cons. Finding a car loan option that has the least amount of financial snags for you and your budget is key, whether you finance through a bank or dealership. You can use our finance calculator to estimate monthly payments and the total interest based on the car’s price.