What is Car Finance?
A car finance contract is an agreement between an individual or group to borrow a certain amount of money from a financier , or ‘lender’, in order to purchase a vehicle. The borrowed money is then paid back over a number of months, at an interest rate agreed to by both parties. The lender is usually a financial institution like a bank, but it can also be an individual, a public group, a private group.
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How to get your car loan approved
Many people have their car loan application rejected. Here are some tips for ensuring that your next application is successful:
How much can you afford to spend?
Subtract your monthly expenses from your income after tax to determine how much disposable income you have every month. Use CarZar's car affordability calculator to determine how much you can afford to spend on your new vehicle finance. Consider the running costs of the car - maintenance, servicing, possible repairs, fuel - and make sure it fits comfortably in your disposable income.
Settle your debts
Vehicle finance providers record-check all credit profiles. Therefore it is critical that those applying for a car loan to settle as many debts as they can. To check whether the applicant is a reliable debtor, financiers can examine how your manage the monthly payments on your credit cards, home loan, or clothing accounts..
Save up for a deposit
Not only does putting down a deposit come across as being financially responsible to the financier, but it also a reduces the asking credit amount and in turn, the monthly vehicle finance repayment amount.
Types of Motor Vehicle Finance
There are a number of different car finance options, and it’s important to understand the option that best suits your circumstances.
1. Personal Loan
A personal car loan, or an unsecured loan, involves borrowing a lump sum over a fixed term in order to secure instant vehicle ownership. Once the money has been transferred to the dealer, you will own the car and be able to sell your second hand car privately without having to settle any funds with the financing institution first.
Personal Loan: Pros
- Paying with cash allows you to negotiate a good price on your new car.
- As long as you make your monthly payments, the car cannot be repossessed by the finance institution.
- You can sell a car as long as you ensure your monthly motor vehicle finance repayment amount is paid up.
Personal Loan: Cons
- Requires a perfect credit history.
- Lenders only provide a maximum set car loan value - check with the appropriate finance institution as loan values may vary.
2. Personal Contract Purchase (PCP)
This vehicle finance option requires an initial deposit followed by fixed loan instalments for your vehicle finance repayment. The vehicle belongs to the financier for the duration of the contract, and at the conclusion of the contract you can either take ownership of the car by paying off the amount still owed to the lender - known as a ‘balloon’ payment - or return the car to the supplier, provided the distance travelled is below the maximum mileage stipulated by the supplier. Monthly payments for this car finance option tend to be lower than other options, so this is a commonly selected option.
Personal Contract Purchase: Pros
- More flexibility.
- Lower monthly instalments.
- Vehicle finance repayments secured against the purchase of the vehicle.
Personal Contract Purchase: Cons
- Responsible for the costs of excess mileage and vehicle damage.
- Large balloon payment equivalent to the market value of the car at the end of the contract.
- Balloon payment interest included in the monthly vehicle finance repayment.
3. Hire Purchase (HP)
An initial deposit on the car finance followed by fixed monthly payments. The deposit is usually 10% of the car’s value, but a larger deposit results in a smaller monthly vehicle finance repayment. At the end of the car finance agreement, you will receive legal ownership over the vehicle. You may also be given the option of paying off the outstanding car finance.
Hire Purchase: Pros
- No imposed mileage restrictions.
- No large lump sum payment required at the end of the agreement.
- Lower interest rates.
Hire Purchase: Cons
- Costly short term agreements.
- Failure to make the monthly vehicle finance repayment can result in a negative credit history and the car being repossessed
Renting of a vehicle over a long period. Requires an initial rental payment, which is essentially a deposit, followed by fixed monthly car rental payments. Can include a maintenance package which covers certain vehicle maintenance services. The car must be returned at the end of the lease period.
- Cars come with a manufacturer’s warranty
- Requires a good to excellent credit rating.
- Responsible for cost of excess mileage and vehicle damage.
- Early cancellation may result in paying up to 50% of the remaining vehicle monthly instalments.
5. Guarantor Loan
A third party agrees to pay the monthly car finance repayment if you fail to do so. Usually required if the candidate has a poor credit rating.
Guarantor Loan: Pros
- Allows those with poor credit rating to finance a car.
- Can improve your credit score if you make the payments.
Guarantor Loan: Cons
- Higher APR.
- Requires someone who is a homeowner to act as guarantor.
How does paying off a car loan work?
Changing the rate at which you pay off a car loan will change the overall structure of your loan. By extending the loan period, the overall interest on your car loan instalments will increase, causing you to pay more over the contract. By paying off the loan quicker - by paying more than the required monthly instalment - you can save a significant amount of money on the reduced interest, as well as improve your credit score for further purchases.
How can I improve my credit history?
- Ensure your personal details on all your financial commitments are up to date.
- Close accounts that you don’t make use of and settle all missed payments.
- Avoid applying to various lenders at the same time.
- Apply for credit cards designed for people with low credit scores.