Buying a car is an exciting milestone, but securing the right loan is just as crucial as choosing the right vehicle. Car loan pitfalls to avoid, such as poorly structured terms, can lead to unnecessary financial strain, higher costs, and long-term regret. Here are key financial mistakes to watch out for when financing your next car—and how to avoid them.
Car loan pitfalls to avoid
#1 Not Knowing Your Budget
One of the biggest car loan pitfalls to avoid is failing to calculate your budget accurately. There’s often a temptation to borrow extra for a more expensive car or motorbike. While not as large as a mortgage, a car loan is still a significant commitment. Remember, a car loan isn’t just about the monthly repayment—it also includes additional costs like insurance, fuel, maintenance, and registration.
How to Avoid This Pitfall:
- Use an online car loan calculator to estimate your repayments.
- Factor in additional car-related expenses when determining affordability.
- Stick to a budget that won’t strain your finances in case of unexpected costs.
#2 Ignoring Your Credit Score
Your credit score plays a key role in loan approval and the interest rate you receive. A high score signals that you’ve managed loans well and are a low risk. A lower score may indicate missed payments, defaults, or frequent credit enquiries, making you a higher risk to lenders.
A poor credit score can lead to:
- Higher interest rates, increasing the total cost of the loan.
- Limited lenders and loan options, forcing you to accept unfavorable terms.
- Not getting a car loan approval.
🔹 Case Study: Mark applied for loans with five different lenders in one week. Each enquiry reduced his credit score, making lenders see him as high-risk. The best loan offer he originally qualified for was later declined due to his “busy credit file.”
How to Avoid This Pitfall:
- Check your credit score before applying for a loan. Dispute any errors on your credit report that could affect your application.
- Avoid applying to multiple lenders at once—each enquiry lowers your credit score.
- Use a reputable broker, like AAA Finance, to manage your application and protect your credit score.
#3 Choosing the Wrong Loan Term
Many borrowers don’t realize that the loan term (length of time to repay the loan) directly impacts their financial situation.
- Short-term loans (e.g., 3-4 years):
- Higher monthly repayments.
- Lower total interest paid over the loan’s duration.
- Helps you own the car outright sooner.
- Long-term loans (e.g., 5-7 years):
- Lower monthly repayments.
- Higher total interest paid over time.
- Risk of negative equity (owing more than the car’s worth).
🔹 Real-Life Example: John chose a 7-year loan to lower his monthly repayments. Two years later, he wanted to upgrade, but his car’s value had dropped below what he still owed—leaving him in negative equity.
How to Avoid This Pitfall:
- Choose a loan term that balances affordability with minimizing interest costs.
- Avoid extending your loan term just to get a lower monthly repayment if it means paying significantly more in interest.
#4 Overlooking Fees and the comparison rate
Car loans often come with fees that can add up quickly. These fees can make a seemingly low-interest loan much more expensive than expected. A comparison rate includes both the interest rate and standard fees, giving you a true cost of the loan. It helps compare loans fairly—a loan with a lower advertised interest rate may have higher fees, making it more expensive overall.
Common fees include:
- Application fees: A one-time fee for processing the loan application.
- Monthly account fees: Ongoing fees for maintaining the loan.
- Early repayment fees: Some lenders charge penalties for paying off your loan early.
- Late payment fees: Additional costs incurred for missed payments.
How to Avoid This Pitfall:
- Always check the comparison rate, not just the advertised interest rate.
- Ask for a full fee breakdown before signing any loan agreement.
- Work with a finance broker, like AAA Finance, to find loans with low fees and the best overall cost.
#5 Accepting High Interest Rates Without Shopping Around
Many car buyers accept the first loan offer they receive, often from a dealership, without comparing interest rates. This can result in:
- Paying thousands more in interest over the loan term.
- Locking into unfavorable terms with limited flexibility.
🔹 Case Study: Lisa was offered a 9.5% interest rate by the dealership but later found a 6.5% rate through a broker—saving her over $3,000 in interest over five years.
How to Avoid This Pitfall:
- Consider using a finance broker to access better rates and loan terms. They compare and negotiate with multiple lenders on your behalf.
#6 Failing to Get Pre-Approval
Loan pre-approval helps you determine your borrowing power before you start shopping for a car. Without it, you risk:
- Falling in love with a car that’s outside your budget.
- Losing negotiation power at dealerships.
- Delays in securing financing after choosing a car.
🔹 Real-Life Example: Olivia shopped for cars without pre-approval. By the time she arranged financing, the car she wanted had sold.
How to Avoid This Pitfall:
- Get your loan pre-approved before shopping.
- Use your pre-approval to negotiate a better car price.
#7 Rushing the Process
The Money Smart website emphasizes the importance of exploring loan options before visiting a dealership. High-pressure sales tactics can lead to signing contracts with high interest rates. Rushing into a loan can result in:
- Accepting higher interest rates than necessary.
- Overlooking important loan terms and conditions.
- Choosing a car that doesn’t suit your long-term financial situation.
How to Avoid This Pitfall:
- Take your time to compare lenders, interest rates, and loan terms.
- Read the contract carefully before signing.
- Seek advice from a finance expert or broker.
#8 Redrawing on your Mortgage!
Many homeowners consider redrawing on their mortgage to finance a car, boat, or caravan due to the lower interest rates compared to a standard car loan. While this might seem like a smart move, it often ends up costing more in the long run. For a full explanation, including calculations using the latest interest rates, check out our detailed blog post: Mortgage Redraw vs. Secured Car Loan
Why This Is a Car Loan Pitfall to Avoid:
- Long repayment terms: A car loan is typically repaid in 3-7 years, whereas a mortgage loan runs for 15-30 years.
- More interest paid overall: Even at a lower rate, the longer timeframe leads to significantly more interest paid.
- Ongoing debt: Cars depreciate quickly, meaning you could still be paying off a car long after it’s lost most of its value.
🔹 Case Study: Michael refinanced $50,000 from his mortgage at a 4.5% interest rate to buy a new car. While the rate was lower than a standard car loan, the repayment period stretched over 20 years. By the time he fully repaid the amount, he had paid over $80,000 due to accumulated interest—far more than if he had taken a standard 5-year car loan at a slightly higher rate.
How to Avoid This Pitfall:
- Keep car loans separate from your home loan to avoid long-term debt.
- Compare the total cost of interest paid over different loan terms before deciding.
- Use a car loan broker (like AAA Finance) to find affordable car loan options that fit your budget without compromising your mortgage.
#9 Not Considering a Deposit or Trade-In
A deposit or trade-in reduces the loan amount, leading to:
- Lower monthly repayments.
- Less interest paid over the loan term.
- Reduced risk of negative equity.
🔹 Real-Life Example: Jake put down a 20% deposit on his car, reducing his loan by $8,000. His lower loan balance meant he could afford a shorter loan term, saving on interest.
How to Avoid This Pitfall:
- If possible, put down a 10-20% deposit.
- Consider trading in your current car to lower costs.
Appy for Car Finance Today with AAA!
Now that you’re educated on the common car loan pitfalls to avoid, you can make informed decisions that will save you money and help you secure the best financing options for your needs.
To discover a car loan solution that is right for you, contact AAA Finance today.
- Easy over-the-phone application
- Most loans are approved with 24 hours
- Competitive interest rates
- AAA customer service
- Experienced finance brokers
AAA Finance works with over 40 lenders, giving you access to a wide range of loan options—unlike banks or dealerships that offer just one or two. This allows us to tailor finance solutions to suit both individuals and business owners. Each lender has unique lending criteria, and we handle the complexities for you, ensuring you get the best loan for your needs.
