Deciding on the amount to borrow for a car loan?

Whether you’re entering the car market for the first time, upgrading your well-travelled wheels, or treating yourself to that dream car, knowing what your budget is and how much money you can comfortably afford to borrow is often the first step in the car-shopping process. One thing that might help save you the heartache of test driving a car out of your budget, is understanding what car loan you may be able to afford before hopping in the driver’s seat.

There are two main types of car loans: secured and unsecured.

A secured car loan may attract a lower interest rate as the bank uses your assets – like the car you’re buying – as security for the loan. This means, in the unlikely event you’re unable to pay back the loan, they’re able to sell the asset to recoup their losses. But, if you’re diligent in paying back your loan, this won’t become an issue.

When no assets are provided as security, it’s known as an unsecured loan. If you’re looking at purchasing a car that doesn’t meet the requirements for a secured loan – like an older used car or a car of lesser value – an unsecured loan could be an option. However, because there is less security for the bank or credit provider, these loans may incur higher interest rates and fees.

The type of loan you opt for will depend on the car you’re looking to purchase, your personal circumstances, whether you have any other assets, and the value of the loan you want to take out.

The amount you can borrow from a bank or lender depends on a few factors, like how much you earn, your monthly spending and your credit habits.

Many banks and credit providers offer a handy car loan calculator to assist you in estimating how much you can borrow. Simply input the amount you wish to borrow and a repayment period and it will calculate your expected weekly, fortnightly or monthly repayments. It will also give you an estimated total loan cost, which is the amount loaned plus the expected interest to be paid over the loan duration.

Obviously, the amount of the calculated repayment, based on the parameters you put into the calculator, needs to be less than your income less your expenses.

It’s important to know that these calculators provide an estimate only, and the amount you can borrow would be confirmed when your loan application is approved.

Simply put, your borrowing power is how much credit you can get from a lender. Depending on your individual circumstances, this number will vary.

When applying for a loan, lenders will look at various factors to determine your borrowing power. The first is your disposable income – what you earn less your monthly bills, mortgage repayments and discretionary spending. They’ll also look at the balance left on any other credit cards and loans you have to formulate a debt-to-income ratio. Lastly, an interest rate buffer – a slightly inflated figure to cover any fluctuations in the interest rate – is added.

By looking at all these numbers, lenders can determine how much you’re able to borrow and how likely you are to pay back the money over the length of the loan.

Your creditworthiness is a measure a lender uses to determine how worthy you are to receive new credit and how likely (or unlikely) you are to default on any repayments.

Lenders will typically evaluate your creditworthiness by looking at how you have handled credit and debt in the past and by assessing your ability to afford the repayments on the amount loaned. You can usually improve it by making sure your bills are paid on time, paying off outstanding debts or credits, lowering the limits on any credit cards in your name, and reducing your outgoings where possible.

Ultimately, the more creditworthy you are, the higher the likelihood of being approved for the required loan amount.

If it’s within the budget, consider making a down payment on the car. Saving even a 10 or 20 per cent deposit will reduce the amount you need to loan and assist in reducing the loan tenure and the total interest paid. This initial outlay could end up saving you hundreds of dollars in the long run.

Like any form of finance, taking out a car loan will impact your credit history. If you make your payments on time, the loan should positively impact your credit rating. But, if you make late repayments or miss them altogether, your credit rating will usually take a hit. Be sure to consider whether these repayments are something you can commit to, even if your circumstances change from the time you took out the loan.

Potential penalty fees – like early pay out or payment default – plus account servicing fees, can all add up over the loan duration. Go over the lenders terms and conditions to ensure you’re across all charges that can be added to your account, and in what scenarios.

There are many different credit products on the market. To ensure you’re making the best decision for you and your current circumstance, spend time online comparing them. Look at the features and benefits side by side from a large range of lenders.

If you’re still unsure what loan will be best for you, enlist the help of an expert. Speak to your accountant or financial advisor to have them go over the options and assist you in choosing a suitable car loan for your situation.