So you've decided to take the plunge to buy a car and are thinking of financing it through a loan. Understanding the differences between secured and unsecured loans (the two basic loan types) can help you work out what sort of vehicle you can afford.
A secured loan is a loan that is borrowed against an asset of greater or equivalent value. This is referred to as collateral and serves as ‘security’ for the amount you intend to borrow.
For example, say you want a loan of $40,000 to buy a ute for general odd jobs around your property. The ute can be relied on as security for your loan. The loan is 'secured' because you've assured the lender that, in the event of you are unable to make your repayments, the amount you’re borrowing is secured against the value on your asset.
The general appeal of a secured loan is that it can allow you to establish and maintain lower rates than an unsecured loan. Depending on your circumstances, with a secured loan, you might be able to borrow a greater amount (compared to an unsecured loan) or stretch the repayment period longer.
The downside is that if you default on the loan you risk losing your asset, depending on what was used to cover the loan in the first place. In the case of a car loan, if you are unable to service the loan, you could lose your car.
An unsecured loan is a loan borrowed which is not secured against a particular asset. A simple example is your credit card or a personal loan. An unsecured loan is generally suitable if you want to borrow a smaller amount, such as to buy a second-hand vehicle for under $10,000.
The general advantage of having an unsecured loan is that you don't have to put anything up as security for the loan, although you are still legally obligated to pay off the debt you owe. Taking on an unsecured loan also means that you might be offered a higher interest rate, a lower borrowing limit and a shorter loan-repayment term (as compared to a secured loan).
Understanding interest rates
An understanding of what interest you need to pay on a loan can not only affect your decision on what type of loan to take, it's also essential to managing your finances better if you're borrowing. Here’s what some common interest rate terms mean:
- A fixed interest rate means the interest rate on your loan remains unchanged for an agreed timeframe, regardless of interest rate fluctuations in the market during that period. So if the market interest rates rise, your repayments won’t be affected. But if they fall, you don’t benefit either.
- A variable interest rate means the interest rate over the term of your loan generally rises and falls according to what’s prevalent in the market.
- Annual percentage rate (APR) is what you pay yearly over the loan term, taking into account miscellaneous fees, service charges, etc. This can vary from lender to lender.
- Effective interest rate (EIR) is simply the interest rate you pay without incorporating any other fees and charges.
Before taking out a car loan, it's important to understand what options are available to you, and what loans would best suit your financial situation. These handy tips could help guide you through the process of getting the right loan for your dream car. Check it out here.
Buying a car is a big financial commitment and it is important to focus not only on the price being advertised but the true cost of owning a car including insurance and other ongoing maintenance costs.
This article provides you with factual information only, and is not intended to imply any recommendation about any financial product(s) or constitute tax advice. If you require financial or tax advice you should consult a licensed financial or tax adviser. Neither Pepper nor its related bodies, nor their directors, employees or agents accept any responsibility for loss or liability which may arise from accessing or reliance on any of the information contained in this article. For information about whether a Pepper loan may be suitable for you, call Pepper on 13 73 77.