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How much can I borrow for a car loan?
When borrowing money for a new car most people have a hard time gauging how much they’ll need. These tips can help you decide how much you’ll need to borrow.
Calculator Assumptions: The above calculations are worked out assuming you’re paying off a principal and interest loan where the interest rate remains the same over the life of the loan. The repayment amounts do not take into account any additional fees or charges that may be charged to your loan (e.g. application fees).
Disclaimer: Whilst every effort has been made to ensure the accuracy of this calculator, the results should be used as indication only. They are neither a quote nor a pre-qualification for a loan.
Why is it important to understand your borrowing power?
When you apply for a type of credit such as a car loan this will be listed on your credit report. It will be listed whether it was approved or not. If there are several enquiries for credit on your credit report it can be a red flag to lenders and can stop you from being approved for loans.Understanding your borrowing power can help you limit the number of applications and enquiries you need to make as you’re only applying for loans that you can afford. It's important to compare a lot of different offers but you don’t want to apply for too many different loans. You also don’t want your credit history damaged by any rejections you receive.
How do lenders determine your borrowing power?
Most lenders use a formula called the Household Expenditure Method (HEM) to determine your borrowing power. This is the closest thing to a one-size-fits-all approach to calculating these factors.
It involves dividing all household expenses into one of three groups: the essential (food, utilities, etc), the discretionary (entertainment, childcare, restaurants) and the luxury (vacations, household staff). The HEM is determined by looking at the median spending on essentials by Australian households, and the 25th percentile spending on discretionaries.
These two values are added together to get the HEM, a number that changes and is updated each year. The number is adjusted in a particular way depending on your location, whether you’re part of a single or partner household and whether there are any children.
The lender will ask you what your monthly expenditure is, and then look at the HEM. The higher of the two sums is used as your monthly expenditure when determining your borrowing power.
The HEM is based on the Australian Bureau of Statistics spending data. It is regularly updated based on the more recent information.
Not all lenders use the HEM. Some have their own formulas or use similar alternatives like the older Henderson Poverty Index (HPI).
How to work out your monthly expenditures
You will generally be required to provide your monthly expenditures to your lender when you apply, despite them making their own calculations as well. For car loans, most lenders will typically want you to give them a single figure, but some might want a more detailed cost breakdown.
Consider how much you spend on essentials. This includes housing, food, utilities, transport and other things you can’t live without.
Factor in how much you tend to spend on discretionary costs and luxuries each month. Resist the urge to exclude these from your calculations. An ideal loan won’t require you to make significant lifestyle adjustments, although this isn’t always possible.
Remember to consider the cost of owning and maintaining a car. There are numerous one-off expenses as well as ongoing costs. These include vehicle registration, licensing, compulsory insurance, additional insurance, petrol, repair and maintenance costs and countless others. However, do not include these in your monthly expenditures unless you already have and are paying for a different car, because your lender will factor them in for you. Do bear this in mind, however, and leave yourself some financial leeway for the costs.
When deciding on the type of car loan you’ll be taking out there are a number of factors you should first consider.
Savings and credit score
Before going for a car loan you should make sure that you're able to repay the loan. The lender you go to will check your credit score and will also look into your savings account history in order to determine that you're capable of repaying the car loan.
New or used car
New cars will obviously cost you more than a used car will but they're also more reliable. No matter which you choose make sure to check the valuation of the car through an authorised source like Australia's Redbook to make sure you're not paying too much money.
Remember the insurance
You'll want to take into consideration paying for auto insurance when thinking about how much you'll need to borrow. If your insurance company requires you to pay a couple of months up front you may want to borrow for this as well. A lender may also inquire about your life insurance or your health insurance. This may seem unrelated to a car loan but a lender may check into it to make sure that you're healthy enough to repay the loan. This may not be necessary and depends on the individual lender.
What factors determine how much can I borrow?
Amount in your savings Lenders will want to look into your savings account to see how much money you have in order to make sure that you’re able to repay the car loan. The amount they find, along with your overall credit history, is one of the main factors that will determine how much a lender will allow you to borrow.
Your total yearly income Your yearly income will also affect the size of the loan you can get. This, like your savings account, has to do with your ability to repay the loan. If the lender doesn’t feel that your income will allow you to repay a larger loan properly they may only approve you for a smaller amount.
Your dependents Lenders will look at your obligations including your dependents to see how your income is being spent regularly. If you have a large family that you care for they’ll take that into consideration.
Monthly living expenses Things like utility bills, credit card bills, student loans, or other monthly bills will also determine how much you can borrow. Your monthly expenses will be looked at in relation to your income and the lender can determine how your money is spent in a given month and how much you’ll have left to put toward your repayment.
Rent or mortgage payments Like your monthly expenses your mortgage or rent payments will be taken into consideration by a lender, too. If they see you are already putting a large amount of your income to your mortgage or rent repayments along with your other bills they may determine that you don’t qualify for a large loan.
How to compare car loans
Car loans, like most loans, are a large responsibility that should be considered from every angle before you actually finalise one. First you’ll want to decide if a car loan is even the right option for you. Then the best thing to do before settling on a car loan is to weigh the pros and cons of the available car loans and compare one to another so you ensure that you’re getting the best deal available. Make sure you look at the interest rates on each loan, the repayment schedule, and fees attached to the loan, the credibility of the lender, and any other options you see.
Interest rates. Look at the interest rate on the loan when you’re presented with the loan details. If one interest rate is lower than the other that loan is probably the better option in terms of your bottom line.
Loan terms. Different loans may have different terms. One car loan may last six months while another may have you carrying a debt for over a year. Compare the terms and pick the loan that is right for you.
Known fees. Some loans may have application fees or service fees attached to them. Make sure you compare these fees and other ones you see so you get the best deal on your loan.
Secured vs Unsecured loans. A secured loan is when a lender has some sort of collateral that acts as protection if you can no longer pay the loan. In this case the car would be their collateral. An unsecured loan is the opposite; there is no collateral or asset held by the lender. This puts the lender at greater risk which usually makes the interest rate higher.
Repayment options. There are usually a range of options available when it comes to repayment of a car loan. There might be specific payment plans available that will suit your needs better than others. Compare these repayment options and decide which loan has the best repayment options.
Car loans are available from a number of different lenders and can come with different options and terms. Be sure to shop around and compare each loan in order to get the best deal.
Matt Corke is Finder’s head of publishing ventures. Prior to this he was head of publishing for Australia, New Zealand and emerging markets. Matt built his first website in 1999 and has been building computers since he was in his early teens. In that time, he has survived the dot-com crash and countless Google algorithm updates.
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