How do car loans work?

Help your hip pocket with the finance know-how you need in your back pocket.

Bamboozled by finance? Asking yourself, how do car loans work? Car loan features vary across different lenders. Luckily, when you understand the building blocks of a loan, how they can be packaged and the pros and cons of each, you have everything you need to choose the right loan for you and buy that new car for a great deal. Let’s help you unravel the mystery.

Recipe for a loan
So, how do car loans work? All loans are made up of the same ingredients. It’s about finding the mix that tastes good to you.

Interest rate
As nice as it would be, loans aren’t free money. You need to pay them back, plus a little more to pay the lender for giving you the money. That’s the interest.

The interest rate, also known as Annual Percentage Rate (APR) or Advertised Rate, is the percentage that you’ll pay on top of the amount you borrow. It’s usually expressed as an annual rate and lenders will factor in things like your credit history, your repayment schedule, the risk (both for lending to you and how the market is going) and their underlying costs to come up with their magic number.

Most lenders have a starting point – the lowest rate they have available. This is their headline advertised rate. But that doesn’t mean they’ll offer you this rate. This low rate is usually available to only a small proportion of borrowers and may come with set conditions to qualify (e.g. a high credit rating plus homeownership).

So before you apply anywhere, it pays to do your research and get a personalised rate from a number of providers. Just make sure that the lender’s quote process is ‘credit score friendly’. That is, they only conduct a soft check on your credit file which won’t impact your credit score.

And remember, the lowest interest rate doesn’t necessarily mean the best loan. You need to consider the total cost of the loan including interest, fees and other costs to truly assess the value of any interest rate on offer.

Comparison rate 
Sometimes you might get a great rate, but the loan comes with whopping fees and other costs. It’s easy to get caught out if you don’t know exactly what you’ll pay. The comparison rate has you covered, as it shows the overall cost of a car loan, including the interest rate and any fees, expressed as an annual percentage. The comparison rate is usually higher than the interest rate charged on the loan.

It’s pretty important – lenders and brokers must provide a comparison rate when they advertise a car loan interest rate under the National Consumer Credit Protection Regulations.

For car loans, there is a standardised measure for how comparison rates are to be calculated and displayed:

  • For car loans 3 years and under, comparison rates are calculated on a $10,000 loan amount over 36 months.
  • For car loans 4 years and over, comparison rates are calculated on a $30,000 loan amount over 60 months

But there’s a catch – not all costs are included. To ensure you don’t get an unwelcome surprise later, you still need to factor in:

  • Government stamp duty and on-road costs
  • Late payment fees
  • Break costs or early termination fees
  • Deferred establishment fees
  • Broker fees (when taking out a loan through a broker, the broker's service fees are not included in the comparison rate, which can be significant) 


You have your loan, you’ve bought your dream car – now it’s time to repay the money. Like most bills, a loan requires regular payments. That schedule is up to you and your lender and can be weekly, fortnightly or monthly. It’s these repayments you need to look at when it comes to managing your budget. And it’s important that the loan repayment calculations have been quoted inclusive of any ongoing fees.

Some lenders also offer a product feature called a balloon payment – a lump sum repayment you make at the end of the loan term. It can be a handy way to manage your cash flow by reducing your regular repayments. But remember, you still need to find the money for the lump sum due at the end of the loan. And you’ll also be paying interest on a higher loan balance along the way.

Upfront fees

Upfront fees are what get you started. Also known as application or establishment fees, they’re ‘one-time’ charges at the start of a car loan. They can include:

  • A flat fee (e.g. $499) that applies regardless of the value of the car loan
  • A tiered fee (e.g. $250, $500, $750) based on the value of the car loan
  • A percentage fee (e.g. 3%) based on the total amount borrowed; and the credit or risk profile of the customer
  • A hybrid fee (e.g. $200 + 2% of the loan amount)

But it’s up to your lender if they charge any or all of these.

Here’s a quirk – establishment fees are usually capitalised to the loan. Even though they’re called ‘upfront’, that’s not when you pay them. The amount will be added to your loan, increasing your total loan amount.

Why is this important? Because you’ll be paying interest on those fees (as part of your total loan). If it’s a small upfront fee, the difference might be a few dollars on each repayment. But if it’s bigger, it quickly adds up.

Monthly or ongoing fees
Also known as account keeping or loan management fees, ongoing fees are paid (usually monthly) across the life of the loan. They go straight to the lender and don’t reduce what you owe at all. Generally the lower the fees, the better. But again, it’s all relative to the total amount you repay over the life of the loan.

Brokerage fees
Brokers can help you navigate the muddy waters of car finance. But they’re not a charity – they do get paid for their service and at the end of the day that’s coming out of your pocket.

In the case of car loans, the brokerage fee is often capitalised to the loan amount. This is usually in addition to the lender’s own upfront fee. They can also have commission arrangements with lenders that are either built into your interest rate or offer them a return based on the final rate you accept. So you need to weigh up if their service is worth it.

Penalty fees
Life happens. When it does, make sure you don’t make a bad situation worse by being pinged with penalty fees you can’t afford. 

The biggest penalty fees to look out for is the ‘default’ or missed payment fee. This fee can be charged when you make a payment late, and often occurs where there are insufficient funds in your nominated account on the day a payment is due.

Late fees vary from $10 to as much as $35, so be sure to keep an eye on your spending, always making sure you have enough in your account to pay the loan, or even set up a separate account dedicated to paying your loan. Some lenders may waive the fee if the account is brought up to date within 3 days but it’s best not to risk it.

It’s a case of buyer beware, so always take the time to read the fine print.

Early repayment fees
Repaying your loan as quickly as possible is a clever strategy as it will reduce the overall amount of interest you pay on your loan. But it can come at a cost – you might get charged for your good work.

Exit fees or early repayment fees are more common with secured low-rate car loans. There are different types:

  • A fixed fee where the loan is repaid in full any time prior to the end of the loan term (e.g. $500)
  • A fixed fee where the loan is repaid in full prior to a minimum period (e.g. $250 if full repayment is made less than 2 years into a 5-year loan)
  • A variable fee based on the amount you would have paid in interest and fees had the loan run to full term

If you think you want to pay your loan down ahead of schedule, pick a loan with low or no early repayment fees to make sure it’s worth it.

Loan amount
How much money would you like to borrow? Yep, that’s your loan amount (plus those upfront fees). It’s what you pay interest on and it’s also known as the “principal” part of your repayments.

In Australia, car loans usually range from $5,000 to $100,000, but some lenders will go higher.

When considering your loan amount, you need to factor in:

  • Loan to value ratio (LVR): How much you’re borrowing compared to how much your car is worth. Most car finance providers in Australia will have a maximum LVR of 140%. For different vehicles, brands, types and manufacturing years, lenders will set specific LVR thresholds.
  • Borrowing capacity: The maximum loan amount you may be eligible for based on your credit score, income, mortgage status and a range of other factors, including the lender’s responsible lending obligations.

It might be tempting to borrow as much as you can for that sweet set of wheels, but make sure your repayments fit within your budget.

Loan term
A loan lets you spread out the cost of your car over a period of time. This time is the term of your loan. In Australia, lenders offer terms between 1 and 7 years, with 3, 5 and 7-year terms being the most common.

So, why does time matter? A longer-term loan might have a higher interest rate and the loan will cost you more overall. But when it comes to managing your budget, your monthly car loan repayment will be lower. It’s about what works for you.

Customer experience
When it comes to your car loan, customer experience isn’t just the sprinkles on top, it’s the plate your dish is served on. Without it, things can get messy.

Think about how quick and easy it is to apply, get approved and manage your loan. Knowing you have a lender who cares about your experience can go a long way towards trusting you’re getting the best deal.

Anything else?
The last piece of the puzzle is your car. Whatever type of car loan you’re looking at, always check for vehicle restrictions including:

  • The maximum age the car can be at the end of the loan term
  • What types of cars and vehicles can be funded (e.g. electric vehicles, utes, vans, etc.)?
  • Can you buy used or second-hand vehicles? If so, does it have to be through a dealer or can it be a private sale?
  • Should I get pre-approved for a car loan?

You might also be wondering when the best time is to think about finance. You don’t have to wait until you find a car to buy – you can actually get a pre-approved car loan.

To give a loan pre-approval, the lender follows the usual process of assessing your situation. Then when it comes time to buy, you know you’ll have enough money and it also gives you a firm budget, helping to speed up and make negotiations (particularly with dealers) smoother and easier.

Just remember, pre-approvals are only valid for a few weeks, so you need to be motivated to buy. You’ll need to make sure the car meets the conditions of the pre-approval or you will need to re-apply. Also, not all lenders offer pre-approval.

What can I use it for?

New car loan, used car loan or something else. Find your perfect match.

Looking for a car that puts the 0 in odometer? Or happy with something that’s been around the block a few times? Your choice of car can affect your choice of loan. Let’s take a look at what exactly you can use each type of loan for and what conditions come along when you choose between a new car loan and a used car loan.

For that new car smell

If you love all things shiny and new, then you’re probably eyeing off cars straight out of the factory. But a new car loan isn’t just for brand new arrivals – some lenders will let you use a new car loan for a car that is 1, 2, or even 3 years old.

You can get either a secured or unsecured new car loan as an individual Australian resident or as a business, depending on the lender. To be considered eligible for a car loan you will generally need to:

  • Be aged 21 or over
  • Be an Australian citizen or permanent resident
  • Be able to demonstrate a regular source of income
  • Have a good credit history.

For those preloved wheels

Got your eye on a car that’s too old to qualify for a new car loan? Try a used car loan instead.

A used car loan works in the same way as a new car loan. You can either apply for a loan first and get pre-approval so you know how much you have to spend on a car, or you can find the car you want and then apply for your required loan amount.

Either way, the lender will need to see all your car’s details before you can be fully approved. But they also might put extra conditions and restrictions on a used car loan, such as how old the car can be. The number of restrictions placed on your car loan also depends if you’re using the vehicle as security for your loan.

A used car loan allows you to enjoy a lower interest rate than you would receive if you were to finance through a credit card. Typically, the average interest rate of a car loan is between 5% to 17%. However, used car loans often attract lower interest rates and borrowers with a good credit rating can see their interest rates lowered to anywhere from 5% to 10%. 

It’s important that you compare car loan rates in the early stages of your car hunt, as some lenders may have restrictions on vehicles that are older than 12 years at the end of the loan term. You want to get the best rate possible for a used car loan. Once you have this information, you can start to get an estimate on how much your repayments will be and if you have to pay at a fixed or variable rate.

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