So you'd like to buy a new set of wheels, but how should you go about paying for them?
Would you be better off paying cash or taking out a loan? What are your options when it comes to car finance?
In this article, we'll compare the pros and cons of various car finance methods.
Should You Pay Cash For a Car?
Paying cash is a great option when you have lots of it to spare. There are no borrowing costs, no repayments and you don't need to go through the process of applying for a loan.
If you don't yet have the cash on hand you'll need to budget and save. Realistically, how long will that take?
If you choose to pay cash, how sound will your finances be once you've made your purchase? Would running and servicing costs lead to cash flow problems further down the road? And would you be able to cope with any unforeseen expenses?
If you're in a position to pay with cash, it ultimately comes down to personal circumstances as to whether it's the best option or not. Just be sure to consider your other options.
This is, by far, the most popular way to buy a car. With interest rates at record lows, it's never been cheaper to take out car finance.
Australia's official cash rate between January 2005 and July 2015.
Car finance can be structured so that you get a fixed interest rate for a fixed term. That makes your repayments predictable. From the outset you know what your monthly repayments will be and for how long you'll be paying them.
Another common feature of car finance is the option of a balloon payment at the end. Balloon payments make the process of paying off your finance more affordable. They allow you to just repay the amount by which your vehicle depreciates during the 3-5 year term. At the end of the term you make a lump sum payment to cover the balance.
The beauty of this method is that you can sell your car at the end of the term and use the proceeds to cover the balloon payment. It's an affordable way to change your car every 3-5 years. Alternatively, you can opt to take out another loan to cover the balloon if you want to keep the car.
There's a huge range of car finance packages on offer, all different and geared towards different needs and borrower niches. Without expert knowledge, the choice can be overwhelming and confusing. As such, the guidance of a broker like stratton can be invaluable in helping you choose a package most suited to your needs.
There are six major categories of car finance:
You can learn more about the different finance methods here: Your Car Finance Options. Alternatively, why not call a stratton car finance consultant on 1300 STRATTON (787 288) for advice?
Using a Credit Card
Using a credit card to buy a car may seem like a convenient option and you might be keen to receive the rewards points, however, it's important to do your research beforehand. The last thing you want is for your $30,000 new car purchase quickly turning into a $45,000 one courtesy of sky-high interest rates.
Be sure to fully understand the terms and conditions of your card including its interest rates, limit, and any associated surcharges before making any such purchase. Car dealers pay a merchant surcharge when their customers use a credit card as the method of payment and this can range anywhere between 1% and 3%. In most cases this surcharge is passed directly on to you.
Typically, using a credit card to buy a car would not be advised with the above alternative methods representing better options. The only instance in which it may be considered favourable is when the car is of a very low value - when in fact, a credit card may be your only option.
Using Your Home Loan
Re-drawing on your home loan to buy a car can seem like an attractive option.
If you have a flexible mortgage that allows you to re-draw on your equity, you can use accumulated equity to pay for your car.
The chief benefits of this method are the convenience of not having to apply for a new loan; also the ability to take advantage of mortgage interest rates, which are generally lower than car finance rates.
Without care and discipline, however, this can be a disastrously expensive option.
Firstly, it's worth checking to make sure you won't incur re-draw fees.
Secondly, you'll need to increase your mortgage repayments to a level where you'd pay off your car borrowings within 3-5 years in order to take advantage of the lower mortgage rate.
The deceptive allure of re-drawing against the mortgage is that you can buy your car now without having to make substantially larger repayments or indeed just paying the interest on what you've borrowed. This would be a huge mistake. Spreading the costs of a car loan repayment over the full term of a mortgage can easily triple or quadruple your borrowing costs!
Consider the example of a $30,000 car financed with a regular car loan or added to a 23 year mortgage.
Regular car loan repayable over 5 years at 5.5% vs. Added to home loan, repayable over 23 years at 5%
The negative equity trap
Another danger of using your home loan is the risk of falling into negative equity territory.
Negative equity is when your outstanding mortgage exceeds the market value of your home. It makes moving or selling your home difficult. With negative equity, you're effectively trapped in your existing home unless you can find the lump sum needed to pay off the outstanding mortgage balance after selling your home. If your outstanding mortgage represents more than 80% of the value of your property you should take the risk of negative equity seriously.
Once you've redrawn on your mortgage to pay for your car, it may just take a small decline in your property's value to push you into negative equity territory.
Refinancing your home loan to access more funds
If you've accumulated equity in your home another alternative might be to refinance your home loan.
Mortgage refinancing involves transferring your mortgage to a new lender who offers more advantageous terms or extending your existing loan facility for the funds you need.
As we've already mentioned, interest rates are at record lows, so you may well be able to find a more attractive deal that also allows you to release some of the equity in your home.
Small reductions in interest rates can make a huge difference to the total cost of financing over the mortgage lifetime. So you may find savings on a better mortgage deal can help you meet car loan repayments without the need to release equity. However, as with drawing on equity in the previous example, spreading car repayments over longer than five years does have its risks.
Mortgage refinancing can work particularly well if your credit score has improved since you mortgaged the property or your property's value has appreciated substantially. At the same time, it is important to ensure you have been meeting your current home loan and other debt commitments (like a credit card) on time as not doing so can impact your ability to get a better property finance deal.
The downside of refinancing is that you'll have to go through the process of revaluing your home and you may be faced with refinancing fees.
Could you use some expert help in sourcing a car loan? stratton car finance consultants have access to some of the most competitive interest rates and finance packages on the market. Start by getting an online quote in 60 seconds today.
If you're interested in mortgage refinance we can help with that too.