Car Loan or Car Lease: Which One Should You Get?
You know it’s time for a new car when your old vehicle keeps stalling or breaking down. However, choosing between buying your next vehicle with an auto loan or leasing it can be confusing since both have benefits and drawbacks. It's essential that you choose the right one for your needs and financial decision because one may not work out favourably for your situation.
Here’s what you need to know before going to the dealership.
A Car Loan Involves Borrowing Money to Buy a Vehicle
In Australia where the average price of a new car is around $25,000 and the cost of living is high, taking out a car loan is one of the easiest ways to own a vehicle.
Instead of paying all the amount at once, you simply need to provide a down payment (usually 20% of the car's total purchasing price) and drive your desired vehicle right away. Meanwhile, the remaining balance will be paid in instalment with interest over an agreed period and repayment frequency.
Types of Car Loan and Their Benefits
Personal Car Loans - You + Lender
This vehicle financing is offered by banks, credit unions, and auto lenders. Typically the simplest loan option, you just need to prove your creditworthiness and financial capacity for repayment to borrow money for buying a new or used car. Your lender will present you with two options: secured, where you have to pledge your car as collateral for the loan, and unsecured, where you won't need to provide any collateral in exchange for a higher interest rate.
- The repayment period and repayment frequency are flexible and can be tailored to your convenience.
- Fixed-rate offers a predictable repayment plan that helps with your budgeting.
- Variable rate helps you save more on interest when the interest rate goes down.
- You're like to get a low interest rate when your car secures the loan, although it can be repossessed by your lender if you default on repayments.
Chattel Mortgage - You (as a business owner) + Lender
A chattel mortgage is a car loan exclusively for vehicles that will be used for business at least 50% of its lifetime. It typically has a fixed-rate term. When you get approved, you're granted the full amount to buy the vehicle. In turn, the car will be used as security for your loan. You have full ownership of the car from the moment you buy it.
- You can claim the total GST immediately after buying the car, instead of claiming it throughout the term of the loan.
- The depreciation of the and the interest portion of the loan are tax-deductible.
- Your repayments have a fixed-interest rate, making them predictable and more manageable.
- The length of the loan is flexible, making your repayments affordable.
- You have a balloon payment option.
- You will likely pay a lower interest rate than other financing plans since your car secures the loan.
You will pay interest and other loan-associated fees.
Most car loans come with an interest rate that can be high or low, depending on your credit history and down payment amount, as well as on the type of vehicle you choose.
Aside from the interest rate, there are other fees that come with your loan, such as:
- Origination Fees – Charged for processing a new loan
- Establishment Fee – One-off upfront fee for setting up a car loan
- Monthly Account-keeping Fee – Charged for managing your account every month
- Statement Fee – Charged for having your statement sent to you
- Late Payment Fee – Charged for failing to pay your monthly repayment on its due date
- Early Termination Fee – Charged for failing to fulfill the repayments over the life of the loan (When you choose to complete your loan earlier than its loan term, your lender will no longer earn the monthly interest that they expect to get in exchange for lending you the money to buy your car.)
These loan-associated fees differ from one lender to another. Some do not charge them, while others require more payments for other loan-related services that are not listed here. It is important to include all the loan-associated fees when comparing and calculating car loans because they affect the total cost of your loan, as well as your monthly repayments.
Risk of late payments, default, and repossession
All loans bring with them the risk of default. If you fail to make on-time repayments on your car loan or, worse, stop paying for it altogether. This will negatively affect your credit score, making it harder for you to secure financing in the future. Even if you're able to get a loan with a history of late payments or default, your interest rate will be high and your loan terms will not be as friendly as it used to be.
If your car is secured against your loan, it will also be repossessed by your lender and sold to others in the hope of taking back the money they lost to you. The repossession record will also stay on your credit profile for seven years, severely affecting your credit score and your creditworthiness.
Being underwater on your car loan
Your car is a depreciating asset. Even if you religiously pay your car loan repayments on time, your car will lose value throughout the loan term. Like all cars, your vehicle depreciates in value the moment you've driven it off the lot and in several years after taking out your loan, you would be paying for a loan amount that's significantly higher than the market value of your vehicle.
For instance, you take out a loan to buy a car worth $30,000. Over the life of the loan, you'd be paying this amount, plus the interest and the associated fees of your loan. Throughout this period, your car's value gradually depreciates so by the end of your loan term, it could be worth only $15,000. The longer your loan term, the deeper you get underwater on your loan.
Being underwater won't be a major issue if you're planning to keep your car forever. However, if you plan to sell it after several years of use, it's a bummer.
A Car Lease Involves Paying to Use a Car for an Agreed Period
Car leasing is, in a nutshell, paying to use the vehicle. Your lessor buys the vehicle from a dealership and lets you drive it in exchange for monthly repayments. This is for an agreed period that's usually longer than renting. When the lease period is over, you return the vehicle to the lessor or pay its residual value to own it.
A car with a high residual value often indicates a good leasing agreement.
Car lease repayments are calculated based on the total cost of the vehicle, interest and other fees involved. The interest compensates the lessor for tying up its capital during the lease term.
Novated Lease - You + Your Employer + Lender
In a novated lease, there are three parties involved: you (the borrower), your employer, and the lender. When you take out the loan, your employer is responsible for paying the lender. However, the repayments are taken out of your pre-tax salary. When you move employment, you can take the car with you and transfer your lease to your new employer. At the end of the lease period, you can buy the vehicle for its residual value. However, you will be responsible for paying the other costs of the loan, like car insurance and registration.
- You will not pay GST on the price of the car.
- You can choose your preferred vehicle type.
- You can use the car without restrictions.
- The repayments are fixed over the term of the loan.
You will pay less cash upfront.
While some lessors do not require a security deposit, most will usually require you to provide an amount up front that's equivalent to a month or two repayments. This money sets the ball rolling. Nevertheless, it is typically smaller than a car loan down payment. You can also claim it at the end of your lease or you can use it to pay for the excess charge you'd incur.
You are not obliged to buy the car.
Although you can buy a leased car for its residual value, you're not obliged to it. This means that you won't get stuck with driving an old, depreciated car after several years of driving it.
You will drive a new car.
Cars for lease are usually new, which means that they come with the latest infotainment and safety features. New cars generally get the safety net of a manufacturer’s warranty.
Your driving experience will be affected by certain lease conditions.
Your lease agreement will come with several conditions, including the number of kilometres that you’re allowed to drive.
Unlike driving a car that's purchased with a loan, you're not free to drive the car however and wherever you want to.
Typically the "allowable miles” are between 12,000 and 15,000 per year. Going beyond this distance will incur an additional charge. The excess uncontracted miles, usually expressed as a cents per mile charge, are paid at the end of your lease.
Another leasing condition is the limit of wear and tear that your car can have when returning it to your lessor. Depending on your agreement, scratches and body damage that are more than 2 inches in diameter and cracks or stains that are more than 1/2 inch may be considered excess wear and tear that you need to pay for.
You can’t modify the car.
Regardless if the modification is needed for work or not, you are not allowed to do it simply because you do not own the vehicle. If you've leased a car with an ugly interior, you will have to live with it until the end of your agreement.
You won’t own the car.
You need to return back the car to its rightful owner, your lessor when the leasing period is over. Otherwise, you will have to buy it for its residual value.
So, which one is better for you?
It may be ideal for you to loan a car if you're running a business or plan to keep the car forever or use it for a very long time. A car loan is also a smart choice if you do not want to be limited in terms of driving distances or car upgrades.
However, if you're running a startup with unpredictable cash flow, car leasing may be better for you. If you're planning to use the vehicle for a short period or do not have the means to maintain a car for a long time, leasing may also be an ideal move because its monthly repayment cost is cheaper.
Positive Lending Solutions can help you find an affordable car loan or novated lease plan from our wide network of lending partners across Australia. Call us on 1300 722 210 or fill out the Loan Pre-Approval form now.