Let’s face it, if you’re reading Drive you probably like cars … a lot. That means you’re more likely to be thinking about make, model and colour than the best way to finance the deal when the time comes to purchase. The danger is that in making the wrong choice, you could end up paying a supercharged price for a mid-range car.
When it comes to the financing, people just want to get it done rather than spend time weighing the alternatives, says a financial planner with Multiforte Financial Services, Kate McCallum. “A lot of the emotion and energy seems to go into, ‘Which car will I buy? What options will I have on it?’
“The golden rule is if it’s a depreciating asset, it’s a good idea if you don’t have to borrow or you can minimise your borrowing.”
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An analyst with financial products researcher Canstar Cannex, Joshua Zenas, says a car purchase isn’t regarded as good debt because the borrowing isn’t for something that will appreciate in value. “With this in mind, working out the cheapest borrowing option and being disciplined is the key,” he says.
“They say not to get emotionally attached when buying a home, because that’s when you make mistakes. I think the same applies when it comes to a car.”
Calculations by Zenas show that “borrowing” from yourself by redrawing $30,000 from your mortgage, at an interest rate of 7.2 per cent, could cost you $26,700 in extra interest on your home loan by the time you clear it 20 years later. That’s your second car right there.
There is a solution – but more on that later.
In comparison, a car loan at 10.4 per cent would cost about $8560 in interest over five years. Using your credit card – yes, some people do want the reward points that badly – or a loan or lease with a similar interest rate would turn your $30,000 purchase into a $45,000 one.
When considering your options – and different ones suit different people for various reasons – make sure you’re comparing apples with apples by ascertaining the total cost of the deal for which you’re signing up.
How much interest will you pay during the life of the loan? Are there any fees and charges on top of that? Are there “break” costs if you pay the loan back early? How much will the monthly payments on a lease cost over its life and will you still have to write out a cheque at the end?
Let’s look at the pros and cons of the five main financing options in more detail.
At last count there were about 400 personal-loan products on the Australian market. Personal loans, including car loans, are either variable rate – where the rate can move up or down at any time – or fixed rate, in which case the rate is anchored at the time the loan is taken out.
Such loans can also be secured or unsecured. With a secured loan, the lender has rights over an asset should the borrower stop making repayments. That’s why interest rates on secured car loans tend to be a bit lower than on unsecured personal loans – because, as a last resort, the lender can repossess the car. In turn, loans for new cars tend to have lower rates than loans for used cars, because lenders consider a used car a riskier asset than a new one.
Credit unions account for all 25 of the car loans Canstar assigned five stars for “outstanding value” earlier this year. All but one of those loans had no monthly service fee and many had no application fee. The cheapest loan at the time was Community First Credit Union’s Green Loan at 6.49 per cent (aimed at more environmentally friendly vehicles such as hybrids), though 7.8 per cent (Companion Credit Union) was about as good as it got for a standard car.
Young people without a mortgage are the main users of car loans, Zenas says.
He says while they’re cheaper, secured car loans require more documentation – with attendant fees – than a standard personal loan. And, when interest rates are falling, you may prefer the manoeuvrability of a variable personal loan. Also, there are break costs if you pay a fixed-rate loan off early.
A private clients partner with accountants Pitcher Partners, Steve Fornasaro, says with a smaller loan it won’t break the bank to pay a couple of percentage points more to get the flexibility or features you need.
Good for First-time buyers.
Pros Simple to understand, straightforward when budgeting.
Cons Interest rates range as high as 16.4 per cent.
Tip Avoid application fees (up to $250) and monthly fees (up to $10) and you’ll save as much as $850 over a five-year loan.
On the face of it, the cheapest form of finance is your mortgage, with standard variable rates averaging 7.2 per cent. These days, most home loans come with an offset or redraw facility that allows you to make extra repayments while still having access to the money if you need it.
How easy is this? Redraw $30,000, pay cash for the car (maybe even negotiating a discount), then drive off into the sunset.
But there’s a catch. While car loans have one- to seven-year terms, your mortgage may have 20 years left to run. And the longer you owe money on your car, the more it costs you.
A straight-out borrowing of $30,000 at 7.2 per cent would cost you about $5800 in interest over five years. But you’re not borrowing over five years.
In Canstar’s illustration, when you redraw $30,000 but don’t compensate by bumping your mortgage repayments up, you’ll pay $26,689 in extra interest over the remaining 20 years of your home loan. Congratulations, you’ve just turned a family sedan into a luxury car.
“You don’t want to spread the cost of your vehicle over 25 years – just because you do that with your mortgage doesn’t mean you should do that with your car,” Fornasaro says. “Take advantage of the lower interest rate but not the extended term.”
The solution? If you bumped your home loan repayments up by $597 for the next five years you’d pay just $5812 in extra interest – the result you were expecting.
Good for People who “save” into their mortgage.
Pros Readily available; interest rates as low as 6.7 per cent.
Cons The trap is you could turn short-term debt into long-term debt.
Tip Put the amount you would have paid for a personal loan or lease on to your mortgage to repay yourself.
Dealer finance is a tricky area. People talk about pressure from on-site business managers to sign up for easy finance so you can “drive away today” – and there’s a perception this sort of finance is expensive.
However, automotive finance providers such as St George Bank argue this is a misconception and that dealer finance stacks up when you consider the total cost of other alternatives.
A former dealership finance manager who worked in the industry some years ago says staff bonuses were linked to sales targets for finance as well as cars and dealerships earned a cut from the finance provider that rose as they got a greater percentage of customers into loans.
He suggests gaining the upper hand in negotiations by visiting a dealership later in the month, when the sales and finance managers are running out of time to hit their targets. “I’d be going in there at 3pm on a Saturday at the end of the month,” he says. “If it’s the end of the month, this sale might make their bonus for them – and at 3pm they just want to go home.”
Zenas advises turning up with pre-approval for a well-priced loan elsewhere and suggesting the dealer beat it.
The NSW manager for automotive finance with St George Bank, Michael Rickard, says one in three people financing cars do so through a dealer. The average rate written via St George’s dealers is 12.95 per cent, including commission, and he thinks a fair comparison is with the 14 per cent to 16 per cent interest on an unsecured personal loan.
“You’ve got to look at the total cost,” Rickard says, including all fees.
He, too, points to the trap of paying a car off with home-loan money over, say, 20 years. Rickard says in the dealerships St George Bank works with, finance people all undergo training and will have to comply with the responsible lending laws that take effect on January 1.
Good for Tough negotiators.
Pros Convenience – it’s a one-stop shop.
Cons Usually more expensive than a credit-union loan.
Tip Look closely at finance packages that have insurance and other extras built in, because you might get the add-ons cheaper elsewhere.
Car manufacturers also offer finance and lease deals. Audi has just launched a finance deal for its new A1 hatchback that packages the price of the car, servicing and insurance into a weekly payment starting from $169.
The negative is you don’t own the car at the end of the agreement, so you have to make a one-off balloon payment or hand the car back.
There are also more traditional loans on offer. Toyota Australia, for instance, has a special rate of just 2.9 per cent for “approved private buyers and certain ABN [Australian Business Number] holders” on its Yaris and Corolla models. It is, in effect, a discount wrapped up as finance.
The four-year loans are on offer until January 31 and buyers can lower their repayments even further by making a final “balloon” payment of up to 40 per cent at the end of the four years.
Fornasaro advises analysing such deals carefully. “Sometimes they’re really good and sometimes they have all sorts of conditions attached,” he says. “You could even go to someone else and say, ‘How much could you do this car for me per month?’
“I’d rather pay $5000 less and get my own finance than pay $5000 more to get 2.9 per cent. You should negotiate the price of the car first, then worry about the finance.”
Good for People not wedded to a particular model.
Pros You get a new car with low monthly repayments; the manufacturer moves surplus stock.
Cons You may have a lump sum to pay at the end and models are restricted.
Tip Shop around for a discount on price that could outweigh the interest-rate saving.
Leasing isn’t as attractive as it used to be, with falling income-tax rates and rising tax thresholds reducing the savings to be had when your employer puts a car through your salary package.
The most popular way of packaging a car is through a novated lease, which is a three-way contract involving the employer, employee and lease company.
The managing director of Custom Fleet, Jim Cock, says that as part of a salary package, the employee leases a car and transfers (novates) the rights and obligations to their employer, who makes the lease payments.
The employer then deducts the lease payments (and perhaps running costs) from the employee’s pre-tax salary, thus lowering their taxable income.
However, the flip side is the employee becomes subject to fringe benefits tax for the car arrangement. The trick is to make sure the FBT doesn’t outweigh the income-tax savings. This will depend on your marginal tax rate and how many kilometres you drive – the FBT rate falls as the kilometres you drive rise.
Cock says these days the true benefit of novated leasing is that FBT isn’t assessable on the portion of the lease payment that’s set aside to meet running costs.
So, in effect, you’re paying for maintenance and petrol from pre-tax salary. You have to arrange a lease using this “employee contribution” method for a lease to be worthwhile if you’re below the top tax threshold of $180,000.
Even then, there’s probably not much in it for you if you earn less than $100,000 and drive fewer than 15,000 kilometres.
The other important factor in leasing is residual value – the value the leasing company estimates the car will be worth at the end of the term.
If the car turns out to be worth less than this, you have to meet the gap.
And if you decide to buy the car outright at the end of the lease, you’ll pay GST on this residual.
For that reason it pays to structure the lease to have as low a residual as possible, especially in a vehicle market where values are falling quicker than ever, Fornasaro says.
He suggests negotiating a residual that’s 20 per cent of the price after four years, rather than 50 per cent. You might achieve this by making a lump-sum payment up-front.
“Make sure there’s some equity in the car so you don’t have to write them a cheque for $10,000 or $15,000 at the end – which is happening a lot,” he says.
This is a complicated area, so get independent, personalised advice from an accountant or planner.
The cost-benefit analysis will be different if you have a small business.
Good for High-income earners who drive a lot.
Pros Tax savings; access to a better-quality car.
Cons Falling car values can leave you out of pocket at the end of the lease.
Tip Check the price of a three-year-old model of the car you want – you’ll get an idea of how far it might fall in value.
Lease to please
Resale value is an important consideration when leasing a car, says the managing director of Glass’s Guide in Australia, Santo Amoddio.
You want to be “square” at the end of a lease, not “upside down”, where the car is worth less than the residual agreed at the start of the term.
But people tend to overestimate resale value, perhaps deliberately because they want to make their monthly payments more affordable, he says.
Amoddio says the average car loses about 50 per cent of its value over three years, possibly more if it has done a lot of kilometres.
Colour is another big factor in resale value. You may love the colour orange but silver, white and black are easier to sell.
“Instead of buying [leasing] the base model and adding options, buy the model up,” Amoddio says.
The options that add more value are those you can see, such as the spoiler and alloy wheels, rather than the invisible airbag.
Have the car serviced regularly and keep the maintenance records.
Dollars and sense
There’s a bigger cost to buying a car than just the interest rate and fees. There’s also the opportunity cost.
A financial planner with Multiforte Financial Services, Tony Clark, says when clients come to him about financing a car, usually with a novated lease in mind, he tries to get them to see the bigger financial picture.
Whether the tax savings of a novated lease are real or not is one issue to consider. Clark says leases also tempt people to buy more expensive cars than they would otherwise.
That’s because people just look at the monthly repayment and say, “I can afford that,” without considering whether they really need a $40,000 or $50,000 car.
Clark gives the example of a client who was about to roll-over his novated lease. Clark pointed out to the client that, by lowering his taxable income, the existing novated lease had also reduced how much compulsory super his employer paid on his behalf by $2500 a year.
He suggested the man use the $20,000 equity he’d built up in his existing car to buy a $20,000 car outright.
The money that would have gone to lease payments on a depreciating asset instead went to pre-tax super contributions, which has its own tax benefits and which, in most years, increases in value.
Clark estimated the client could be $150,000 better off in five years’ time by buying a cheaper car outright and contributing more to super.
The true cost of finance
Borrowing $30,000 over five years Borrowing option Average rate PA Interest paid Total cost Factory finance 2.90% $2263.72 $32,263.72 Mortgage redraw (5 years) 7.20% $5812.25 $35,812.25 Car loan 10.35% $8555.40 $38,555.40 Dealer finance 12.95% $10,909.47 $40,909.47 Credit card 17.31% $15,035.22 $45,035.22 Mortgage redraw (20 years) 7.20% $26,689.15 $56,689.15
Source: Canstar Cannex