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Different Types Of Car Loans Explained
●May 14, 2021●6 minute read
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If you’re in the market for a car loan, whether for individual or business purposes, deciding on the right type of financing can be overwhelming. After all, there are many options to consider and each come with their own pros and cons.
In this guide, we breakdown the different types of car loans to help you make an informed decision and get the car of your dreams.
What are the different types of car loans?
Generally, a car loan is the most common and simple way to buy a new or used car. This is where a financial institution, such as a bank, credit union, or lender, agrees to lend you the money to buy a vehicle. You then repay the loan amount, plus interest, over an agreed period of time.
Depending on the lender, you might be given the option to choose a secured or unsecured car loan. An unsecured car loan is a loan that doesn’t require an asset as security. They typically come with a slightly higher interest rate as there’s more risk involved for the lender. On the other hand, a secured car loan requires an asset to ‘secure’ the loan. This means if you fail to meet your repayments, the lender can repossess your asset and sell it to recoup any losses. While an asset can be a house or boat, it will typically be the car you’re buying with the loan. Generally, secured car loans come with a better interest rate.
Types of interest rates
If you were to choose a secured or unsecured car loan, you’d then need to decide which type of interest rate you wish to pay. There are two types of interest rates: fixed and variable.
A fixed rate means that the interest rate and repayments on your car loan will remain the same throughout the loan term. This type of rate can be appealing for those who want to know exactly how much they will repay each month. However, it can also mean you’ll miss out on taking advantage of low interest rates.
With a variable rate, the interest rate on your loan can go up or down, depending on the market. While it offers more flexibility, a variable interest rate can make it difficult to budget for repayments. However, unlike a fixed rate, a variable rate often allows you to make extra repayments or exit the loan early without a fee.
When comparing car loans, keep an eye out for other features such as the comparison rate, interest rate, fees (including application and extra repayment fees), loan term, and any conditions included.
Commercial Hire Purchase
A commercial hire purchase (CHP), also known as a corporate hire purchase or offer to hire, can be a suitable option for business purposes. It is an arrangement where you hire a vehicle from the lender and repay it in fixed instalments over a set period of time. While you have full use of the car during the loan term, the financier has complete ownership until the loan contract is completed. After the contract is completed and all payments (including interest) are settled, ownership of the vehicle is transferred to the borrower.
While individuals can opt for a commercial hire purchase, this type of financing is best suited for businesses. This is because there is the potential to claim tax deductions on depreciation and interest charges if the vehicle is being used for business purposes.
- Tax deductions: There is potential to claim tax deductions on the depreciation and interest charges. Plus, there generally isn’t a goods and services tax (GST) on your repayments.
- Flexibility: Typically with a commercial hire purchase, the repayments and interest rate tend to be flexible for you to arrange. They are also ‘fixed’ meaning you know exactly how much you’re paying upfront and can set up a budget accordingly.
- Ownership at the end: At the end of the contract, you’ll be given full ownership of the vehicle provided that all terms and payments have been met.
- Expensive: It can be more expensive compared to other types of financing. Even though you don’t own the car during the loan term, you generally still have to pay for maintenance and repairs.
- Owned by the lender during loan: One of the downsides is that you don’t own the car during the term of the loan.
A chattel mortgage is when the lender provides the funds to purchase a car (chattel), which is secured against the loan. The borrower repays the amount over an agreed period of time, usually between two and seven years. This arrangement is similar to a secured car loan, except it’s mainly used for business purposes. Generally, you can only get a chattel mortgage if you use the vehicle for business purposes more than half the time.
- Ownership: At the time of purchase, the borrower owns the vehicle outright. However, the lender can take it back if you miss your repayments.
- Tax potential: You may be able to claim tax deductions on the depreciation and interest charges as well as the GST.
- Lower interest rates: Generally, a chattel mortgage comes with a lower interest rate as your loan is secured against the car.
- Risk losing asset: As the vehicle is secured against the loan, you risk losing it if you fail to meet your repayments.
- Less protection: Chattel mortgages don’t fall under the National Consumer Credit Protection Act (NCCPA).
A novated lease is a three-way arrangement between a lender, an employer, and an employee. Also known as salary sacrificing, a novated lease sees an employee use their pre-tax income to lease a vehicle directly from the lender. This can be appealing for those wanting to reduce their taxable income. Plus, the motorist can use the car for personal as well as business use.
- Personal use: With a novated lease, you can use it for personal use as well as for work or business purposes.
- Pay less tax: As you are salary sacrificing, your taxable income is reduced. This can mean you pay less tax overall.
- Fringe benefits tax: In some cases, the employer may deduct the cost of the fringe benefits tax from your pre-tax salary.
- Difficult if you move jobs: If you change jobs, you might not be able to transfer your novated agreement to your new employer. If this is the case, you would need to take over the repayments, which are no longer pre-tax.
An operating lease involves the lender purchasing a vehicle and renting it to the borrower, who holds no responsibility for the risks associated with ownership. For instance, the borrower doesn’t have to pay the residual amount at the end of the lease. This type of lease can be ideal for businesses who will only use a vehicle for a short period of time. When the lease is finished, the borrower can either buy the vehicle outright, continue renting it, or trade it in for another vehicle.
- No risks: With an operating lease, the lessee has no risks associated with owning a vehicle including the residual value.
- Maintenance costs included: Generally, the lease payment includes the costs of operating and maintaining the vehicle.
- Tax deductible: Generally, the lease payments are tax-deductible.
- Don’t own the car: Unlike a financing lease, you don’t own the car. As a result, you can’t make any changes to the vehicle.
- Higher repayments: As the repayments generally include the costs of running the vehicle, they can be higher than other types of car financing.
Which type of car loan should I choose?
Unfortunately, there’s no ‘perfect’ answer when it comes to choosing the right type of car finance. Each type of car financing comes with its own advantages and disadvantages to consider. Ultimately, it’s up to you to decide which type best suits your budget and financial needs. You may find it helpful to seek advice from a professional financial advisor who can take a closer look at your financial situation and help you make the right choice.
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Written by Katie Douglass
Katie Douglass is the Senior Communications Manager at Jacaranda Finance. In recent years, Katie’s work has appeared in publications such as Marie Claire, InStyle, Oiyo, and THE ICONIC. She has a Bachelor of Creative Industries in Fashion Communication & Journalism from the Queensland University of Technology.