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Car Loans
Understanding car loan terms: what you need to know
If you're considering a car loan in Australia, this guide will help you understand the terminology and the factors that affect the total cost, so you can make an informed decision.
Whether you're a first-time car buyer looking for a budget-friendly car, a family considering an affordable SUV or someone interested in hybrids or battery electric vehicles (BEV), finding the right car loan can be a difficult process, especially if you don’t understand the jargon.
Banks, lenders and dealers talk in a specific language, with special terms to describe the different elements to your loan.
This guide aims to help you decipher frequently used terms and phrases for car loans, so you can make this important financial decision with confidence.
More: Research and compare different cars on sale in Australia
Key car loan terms and FAQs
The car buying journey begins with researching and comparing makes and models and deciding what's going to suit your needs. Will it be a family SUV? Do you want a 4WD or AWD? Then you need to decide how you will finance the car. When it comes to car loans, here are some key terms explained.
What is a car loan principal?
The principal is the loan amount, so the dollar figure that you are borrowing for your purchase.
What is car loan interest?
Interest is a percentage of the principal, and is required to be paid back along with the loan.
So borrowers need to understand what the principal and the interest amounts are, as these combine to create your repayment figure.
What is a secured and an unsecured car loan?
A secured car loan uses the vehicle as collateral, meaning the lender can repossess it if repayments aren’t met. Because this reduces the lender’s risk, secured loans usually come with lower interest rates.
RACV Finance, for example, offers secured loans for both new and used cars that meet eligibility criteria.
An unsecured loan, on the other hand, isn’t tied to the car as security. Because there’s no asset backing the loan, interest rates are generally higher and lending criteria can be stricter.
What are loan fees?
Loan fees and charges are also a must to understand. These vary between lenders and can often end up making the biggest difference in terms of cost over the span of the loan.
This is because some lenders can offer attention-grabbing low interest rates, but will then add in ongoing monthly fees and charges, as well as expensive break fees or other costs and restrictions that allow any money lost on the lower interest rate to be recovered or even exceeded during the loan.
If possible, plan your test drive to include the types of roads and conditions you’ll encounter daily.
Interest rate vs comparison rate
The interest rate is a percentage of the principal, so what is a comparison rate? The comparison rate takes the interest rate and adds both upfront and ongoing fees so that you can see what the difference is between lenders.
A comparison rate gives a clearer picture of a loan’s total cost over time. Looking at comparison rates across lenders can help you compare loans more effectively, rather than focusing only on the lowest interest rate.
Estimating your repayments
A good starting point is to use a calculator to estimate your monthly or fortnightly repayments on your car loan. A personalised finance rate can be obtained from RACV in around two minutes, with no impact to your credit score. Don’t forget to factor in insurance, servicing and warranty costs.
Loan term length and total cost
Most lenders offer loans between one and seven years, although five years is the most common. The length of the loan, the number of years it takes you to repay the principal, with interest, has a big impact on both your repayments and your total cost.
This is the balance you need to strike in your personal circumstances. The quicker you pay the principal amount off, the less interest you pay but the higher your individual repayments will be. Alternatively, you can keep your repayments lower by extending the loan period, but you will ultimately end up paying more in interest.
More: Compare up to 3 cars and see the specs, features, ratings and running costs side-by-side.
What is a loan establishment or application fee?
The application or establishment fee is a charge for initially establishing the loan. It is generally added to the loan principal and paid off over the term of the loan.
What are loan account-keeping fees?
There may be account-keeping fees, which are a small recurring cost each month to maintain the loan. Think of it like a subscription cost, which does not carry interest but can add up over the length of the loan. A $9.95 per month account-keeping fee, for example, will add $597 to the cost of borrowing over a 60-month loan period. Some lenders, including RACV, do not charge this type of fee.
What is a car loan early repayment fee?
An early repayment or exit fee is an amount payable if you manage to get ahead on your loan and want to pay it out before the initial agreed loan term.
To highlight how early repayment fees can differ between lenders, RACV Finance General Manager Carlos Gasser points to early loan exits as a common example.
“ It will vary by lender. Most will allow you to make some additional repayments, but it’s important to check the terms of your loan," Gasser says.
"Most lenders, if not all, will charge some kind of break cost if you pay out the loan early – and those fees can vary significantly. RACV, for example, charges a flat fee of $325 if the loan is paid out more than six months before the end of the term. If you break the loan with six months to go, there’s no fee, but anything earlier than that would incur the charge.”
Getting pre-approval means you can shop with confidence.
What is a car loan pre-approval?
Pre‑approval is an often-overlooked step when getting a car loan, but it can make the process much easier and help you shop with confidence. In simple terms, pre‑approval is an early indication from a lender of how much you may be able to borrow, based on an initial assessment of your financial situation.
It usually involves less paperwork than a full loan application and gives you a clearer idea of your borrowing power before you choose a car.
“Most lenders offer some sort of pre-approval,” Gasser explains. “We offer an applicant up to 89 days from when their credit has been approved to then go and search for a car.
“The information in there could be subject to another assessment though. So if you've gone for a $40,000 pre-approval and then you go and find a $50,000 car, we would obviously need to reassess that. But it gives you some comfort that you can go off for a particular amount and know that you can engage and negotiate with authority that you have the funds there.”
What are credit checks?
When you apply for a car loan, the lender will usually run a credit check with a credit reporting body, such as Equifax or Experian, to help assess your borrowing capacity. Applying for multiple finance products or seeking several pre‑approvals in a short period of time can affect your credit score – an important factor in whether your loan is approved and on what terms.
Not all credit checks are the same, so it’s important to understand the difference. A hard credit check is typically carried out when you submit a full loan application. It’s recorded on your credit file and can be seen by other lenders. Multiple hard credit checks close together may lower your credit score and could result in a declined application or a higher interest rate.
A "soft check", such as through RACV’s Get My Rate feature, will usually allow a lender to provide a more accurate price based on your circumstances.
Lenders should tell you if a hard credit check is required and will ask for your consent before proceeding. If you’re unsure what type of check is being used, it’s always worth asking.
R.A.C.V. Finance Limited ABN 82 004 292 291 Australian Credit Licence No. 391488. RACV Finance is subject to RACV lending criteria. Conditions, fees and charges apply.
Advice given in this article is general in nature and is not intended to influence readers’ decisions about financial products. You should always seek your own professional advice that takes into account your own personal circumstances before making financial decisions.
