As I recently learned from a post on my Instagram Stories, everyone’s got their own opinion when it comes to car loans. Buying a car on finance is popular among young people who don’t have the savings to pay upfront for a car, but need a set of wheels to get from a to b.
But, just how problematic are car loans? How will a car loan affect your finances, borrowing capacity, or even credit score? I asked my mortgage broker for the hard facts on car loans.
Are car loans a good idea?
The decision to get a car loan is a personal one, and we all do it for different reasons. When you’re in your first proper salaried job, it’s tempting to take out a car loan to get a flashy new set of wheels to match your new grown up lifestyle, but it could cost you down the track.
“I see this issue all the time when people apply for mortgages,” explained Alistair Jordan of Woodrow Finance Group (and my superstar mortgage broker who I’d recommend to anyone). “People do things in the wrong order. They go on a holiday and take out a car loan – then try to buy a house.”
That said, if your job or lifestyle relies on you having a safe and reliable car, and you don’t have the savings to buy one, a car loan may be your only option – and that’s ok. Car loans when they’re necessary and used responsibly are one thing. Going in to get a loan on a Mazda 2 and walking out with a BMW 3-series because the salesman hooked you in with a fancy model for only a little more extra each month is another issue entirely.
Will a car loan stop me getting a mortgage?
It depends. Alistair explains, “car loans have prevented a lot of people buying a house or refinancing their current home loan.”
That’s because a car loan will affect your borrowing capacity. The bank will assess your income and expenses when calculating your ability to service (repay) the loan, and if you’ve got a $500 a month car loan payment, that’s going to eat into a chunk of your income that therefore cannot be used to repay a loan.
Banks assess your repayment capacity using a serviceability rate. This is when they calculate what your repayments would be on a higher interest rate than what your loan will actually carry, to ensure you can handle a rate hike if and when it occurs.
“A $500 a month car loan repayment can affect your borrowing capacity by as much as $90,000 in some cases,” explains Alistair.
But again, if, without that car loan, you can’t do your job – you’re no better off. In some cases, getting a car loan is simply unavoidable. If your car breaks down unexpectedly and repairs aren’t viable, then you shouldn’t feel ashamed of getting a car loan – providing you’re sensible about it. In this case, though, you may have to accept that you may need to delay a property purchase for a while.
If you do have a choice on when/whether you take out a car loan, however, try and do it when you’re not planning to apply for a home loan any time soon. “Buy your property first”, says Alistair, “then get your car loan.”
Now, that’s not to say a car loan and a successful mortgage application can’t co-exist. Of course they can. It’s really a cocktail of your other expenses, how much you earn, how much your car loan is, and how much you want to borrow. Speak to a mortgage broker before you take out a car loan if you’re planning to buy property any time soon. They’ll be able to run the numbers and work out the impact the loan repayments could have on a mortgage application.
Will a car loan affect my credit score?
All applications for credit can have an impact on your credit score, as your application for finance provides another nugget of information in your credit profile. It will also keep a watchful eye over each monthly repayment and how well you’re servicing that car loan. That said, having credit and making repayments on time each month can also improve your credit score.
What about car leasing?
Car leasing is becoming increasingly popular, and involves leasing the car rather than taking out a line of credit or a loan. That said, the monthly repayments will be factored into your financial assessment in the same way as a loan repayment.
What about novated leases?
Novated leases can be beneficial for those looking to buy property while leasing a car, because the payments are taken by your employer as a pre-tax payment. This can in turn decrease the amount of tax you pay, and potentially increase your net income after tax. It all depends on your income, taxable income and how much you want to borrow.
Should I get a car loan?
It really depends on your situation and the reasons you’re considering getting a car loan. From a financial savviness perspective, no. In an ideal world you’d save up the cash to buy a car outright so that you’re not taking on credit. But that also assumes that you don’t have an immediate need for a car, and that you earn enough to save for a car without having to wait a million years.
If you do look into getting a car loan, speak to a mortgage broker first to see how the repayments could affect your borrowing capacity in future, even if you’re not planning to buy a property right away. Should you choose to go down the loan or leasing route, try to be sensible with your car choice and think about what you actually need. Salespeople are trained to try and get you to upgrade for only a small amount more, and will probably tempt you with something you don’t need. Go into the process with a clear idea of what you want, what your budget is and why if you want to stay ahead of the car loan game.
If you’re in Australia and you’d like to speak to my broker, Alistair Jordan, about your financial situation and how much you could potentially borrow, drop him an email here or slide into his DMs on Instagram. Alistair has looked after mine and my partner’s home loan for over 3 years and I couldn’t speak more highly of him. Several other TBG readers have also used Al and had great experiences.
*if you do use Al on my recommendation, I may receive a referral fee when your loan settles as part of a partnership with Woodrow Finance Group. All referrals are 100% genuine and I have been referring Al long before our partnership was in place.
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