Consumers win in finance shake-up
With the right advice, choosing the right new car shouldn’t be hard, and neither should selecting a suitable finance product.
Of course, that’s rarely the case, as there are as many options to finance a car as there can be paint colours.
Between all of the options - products such as personal loans, car loans and refinancing the family home - have been wildly varying interest rates. However, new rules and regulations introduced on 1 November 2018 have changed the game. Finance companies and dealerships are required to make lending terms more transparent and the ever-important interest rate less is now less variable.
No longer a one-size-fits-all approach, the end result is a win for the consumer, but there are still some finer details to be aware of.
The stricter regulations remove the markup dealerships could once put on a loan product - anything that would have seen a 7 per cent base-rate from the lending bank hike to 11 per cent in a repackaged product from the dealer, adding thousands to the price of a car over the term of the loan.
Now, each applicant to a loan must be vetted and their credit rating assessed, with a unique interest rate given according to that score. The interest rate can have a maximum of 2 per cent cut from it, so a bank interest rate of 7 per cent could end up as an offer of 5 per cent to the buyer, though unlikely as the dealer loses most of its commission from the lender.
Instead, the dealer often makes its profit in the form of commissions, added as a set-up fee on top of the overall loan.
But there are still some tricks to low-rate interest offers.
Zero or super-low interest rate offers are artificially deflated car loans which offer plenty of appeal on the surface compared to traditional consumer loans.
This type of loan is commonly a subvented loan, where the automaker has artificially lowered the interest rate through one of its own financial arms - and there’s nearly always a catch so that the savings in interest are made up for elsewhere.
Zero per cent interest loans are common on only selected stock that is offered at a fixed price. This allows the dealer to recoup the loss of that lower per cent interest rate with a buffer in the price above what a good haggle would win. And the term is usually short – around 36 months – so that minimum repayments remain high.
For instance, if the car was priced at $60,000 at zero per cent interest over 36 months, the profit the manufacturer is losing in finance would be around $5700.
It’s common to find that reduced interest rate loans are only offered on older or slow-moving stock and at a fixed price - these are models that are usually more easy to haggle down on price when bringing your own cash. This includes previous year built runouts that need to be moved on and unpopular base-grade models.
In the end, the loan can cost as much or more than shopping with prearranged finance that allows the buyer to haggle for a good deal – or a great deal if the stock is getting old and sitting around in the back of the yard.
"While the low-rate deal has saved you money in interest, the additional cost on the car has more than absorbed that saving," says executive director at National Fleet Group Junies Lim.
"Plus your loan balance will be higher for longer with the low-rate deal which could have a negative impact should you need, or want, to sell the car during the loan term."
Another appealing option on the surface is refinancing the home to pull out money on a low-interest rate with low repayments. But like a home loan, the repayments are allowed to stretch over a long time - up to 30 years - and that can end up costing a lot more than a conventional car loan that is usually paid off between 1 to 5 years.
And with car loan interest rates available at around 5 to 6 per cent, the interest rate isn’t necessarily going to end up much lower if you have a good credit rating. Plus, there could be monthly account fees for the different types of home loan product that also snowball over the years.
Let’s say you’re looking at a $20,000 car loan over five years with a fixed interest rate of 6 per cent and no fees. The repayments would be $399.56 per month until the term of the loan was finished.
The same loan taken as equity on a 15-year home loan at 4.5 per cent interest would require a minimum payment of just $153 per month.
However, the total repayments of the home equity loan plus interest would be over $4000 more than the personal loan.
The crux of choosing to ask the bank for money against home equity for financing a car is that the repayments must be very disciplined to make it work. It's all too easy to pay off half of what you would pay back per month over a four-year term, and that quickly pushes the loan out into an expensive long-term product.
There are also other potential negatives to a home equity loan compared to a proper car loan product, such as not being able to claim tax benefits and GST savings – further small savings that can add up over the life of a loan.
"When you apply for a home equity loan with good credit, the lender might charge a competitive interest rate as low as 4 per cent per annum or 5 per cent. This is impressive, but the rate doesn’t compare with low rates offered by auto lenders. Well-qualified buyers can get an auto loan with rates as low as 6.5 to 7.5 per cent," says Lim.
"A five-year term is doable for most people but a home loan typically has a repayment term up to 10 to 20 years. Although you wouldn’t finance a car for 10 years (or at least you shouldn’t), a home equity loan gives you the option of paying off the car over an extended period if you can’t find an auto lender to stretch your term beyond five years. Be aware that the longer it takes to pay off a car, the more interest you’ll pay."
These are the traditional type of loan used to buy a car and include the finance that many dealers organise in-house. Of course, that means there’s an extra kicker for the dealer and can sometimes allow a haggling point if bundling a car with finance under the one roof.
Depending on a consumer’s credit history, the interest rate on a car loan can be competitive to most banks and is usually lower for new cars. But there could be monthly account fees and set-up fees that need to be taken into consideration, and these are often added onto the principal of the loan so interest is accrued on that.
Because the loan term on a consumer loan is much shorter than that of a refinanced home mortgage, having to pay off the principal and interest quickly is baked into the cake. As with all types of interest loans, shorter is better.
Depending on the type of loan it will be either unsecured or secured. The latter usually applies to new car loans and it means that if the loan account goes unpaid the debtor can proceed to reclaim its money by taking back the car and selling it.