22 Jun 2021

Should I use my mortgage or a car loan to buy a new car?

As the property and car market runs hot with values rising, a question we are getting more and more often is, should you use your mortgage loan or a car loan to buy a new car?

Well the answer is, it depends. 

The first thing it depends on is what type of car you are buying. Generally for a secured car loan, lenders will require the car to be 12 to 15 years old at the end of the loan term. As it’s 2021 now, if you wanted a 5-year loan term, that means the car cannot be built earlier than 2011. So if you’re considering an older car which is commonplace for imports and classic models, using your mortgage loan may be your only option.

The Biggest Driver of Cost is the Loan Term

Secondly, the good thing about using your mortgage loan is the interest rate is lower, so you would expect to be paying less than using a car loan. However it’s important to remember that interest rate is not the sole driver nor is it the biggest driver of cost (where cost is interest expense). It is actually the loan term i.e. time on the loan that is the biggest driver of cost.

For example, if you borrowed $50K to purchase a car and funded it using a mortgage loan @ 3% pa over 10 years, the total interest cost is $7,936; whereas if the car was funded using a car loan @ 5% pa over 5 years, the total interest cost is $6,614. To achieve approximately the same total interest cost as a car loan, you would need a mortgage loan term of 8 years or less.

Let’s then compare the two loans over the same 5 year term. The mortgage loan’s total interest would be half of the car loan, or a whopping $4,000 in interest savings!

Therefore, you can strategically use a mortgage loan to reduce total interest expense IF the loan term is relatively short as well.

Using a Longer Loan Term for Cash Flow Purposes

By the same token, if the loan term is longer, the ongoing repayments are lower. This can be preferred for cash flow purposes as the repayment amount is smaller.

Generally speaking, secured car loans have a maximum term of 7 years while a mortgage loan could be up to 30 years, although lenders may only approve up to 10 years due to the purpose of funds being for a car which typically doesn’t last 30 years.

If you have lumpy income such as bonus, commission, overtime, weekend loading or self employed receipts then you may want to consider a longer loan term, either with a car loan or mortgage loan to help with managing cash flow.

Either way the key to keeping total interest costs low is to structure the loan to be able to make extra repayments when it suits you but without incurring a penalty for doing so. In this way you still achieve a reasonable loan term and total interest expense. 

Further to this, making smaller repayments by way of a longer loan term and/or contributing a larger deposit can help with preserving your future borrowing capacity for another property. This is because mortgage lenders care about the repayment amount more than the total loan amount when they assess your borrowing capacity in home loan applications.

So if you’re in the market for a new car but not sure how you should fund it, please speak to our Asset Finance and Mortgage Specialist – Luke Xie! He is even able to help you source the car with our buying service.