Your car finance options explained

Navigating the different options to fund a car purchase has traditionally been a confusing affair. And it's this confusion that some car dealers rely on to get you to sign up to a package you don't fully understand.

 

What is car finance?

Car finance is a broad term that covers several different ways of buying a new or second-hand car. It's a useful way of funding a car if you can't pay for it outright yourself.

You might get your car finance from the bank as a personal loan, or through the dealership where you buy the car. The dealer is likely to offer you hire purchase or personal contract purchase deals when you buy a car on finance too.

How does car finance work?

Generally speaking, car finance works like this:

• You buy a car and your bank or finance company covers the cost
• You both agree to a repayment schedule that runs for an agreed amount of time
• You make regular repayments to the lender while you're using the car
• Depending on the kind of car finance, you might give the car back when your agreement ends

What are the different types of car finance?

There are 5 main ways to pay for a car:

• Personal loan
• Hire purchase
• Personal contract hire
• Credit card
• Cash

1. Personal loan

An unsecured personal loan is when you don’t have to offer up any kind of collateral to get the money you need. This means less risk to you.

Pros

• You don’t need to pay a deposit to get a personal loan
• No restrictions on what car you can buy - so you can use a loan to buy an older second-hand car
• The car belongs to you from day 1

Cons

• If you've got a poor credit rating you might not be eligible for the best interest rates. This also applies if you've never had credit.
• The lender could repossess your car if you miss payments
• You usually need to have a deposit

.

2. Hire purchase

Hire purchase (HP) is a secured loan. The security is the car you're buying - so if you don't keep up with the payments, the lender could take your car away.

There’s usually an initial deposit to pay when you use HP, followed by monthly payments that pay off its value. After that, the car is yours to keep.

Pros

• Once you've finished making your repayments, the car is yours
• Could be useful for those who are otherwise ineligible for decent rates on a personal loan
• There's an even spread of repayments over the agreement

Cons

• If you're thinking about selling the car, you typically need to finish paying for it first
• The lender could repossess your car if you miss payments
• You usually need to have a deposit

3. Personal contract purchase

Personal contract purchase (PCP) is like hire purchase. You pay an initial deposit, followed by monthly payments.

But unlike hire purchase, PCP payments cover the car's depreciation only. This is how much the value of the car drops through wear and tear, age and mileage.

You don't actually own the car while you're making payments. At the end of the contract you have to make a large, final payment to own the car outright.

This is often referred to as a 'balloon payment' as it's larger than what your monthly payments would be.

Or, at the end of the agreement, you can swap the car for a different one and get another contract.

Pros

• PCP deals usually have lower monthly payments than with hire purchase
• Initial deposit tends to be smaller than HP
• You have the option of getting a new car every few years or keeping the one you have

Cons

• To own the car you must make that larger final payment
• If you go over any agreed mileage cap, you have to pay extra for every mile you drive over this
• Not usually available on older cars

4. Credit card

It's possible to buy a car using a credit card. This depends on the price of the car and the credit limit available to you.

Generally, it's the kind of thing that you should only consider if you know exactly what you're doing. There are several things that could result in you paying more than you need to, and for a much longer period of time.

But you do get extra protections by using a credit card. This makes it one to consider for cheaper, second-hand models.

Pros

• Paying on a credit card means you own the car outright from day 1.
• Monthly payments can be flexible to suit your circumstances.
• You should get some extra protection thanks to the Consumer Credit Act.
• Some credit cards offer interest-free deals on purchases. So, as long as you pay off your card before the 0% period ends you don’t pay any extra

Cons

• To get a competitive interest rate, your credit rating needs to be excellent
• Most credit cards have a £5,000 limit
• Unless you can get a 0% deal, the APR of a credit card is likely to be much higher than with other finance options
• Many dealers don't accept credit cards due to the fees they have to pay

5. Cash

This doesn't mean handing over a stack of £20 notes to the seller, although that's a possibility. 'Cash' refers to you paying for the car in a single lump sum. This could be paying by:

• Debit card
• Cheque
• Bank transfer

Some dealers might not give you much room for haggling if they know that you’re paying in cash.

This is because many dealers get commission from the finance deals they sell. So if they’re losing out on that potential money, they may try to make up for it elsewhere.

Pros

• You own the car outright
• There are no other payments to make
• You’re able to sell the car whenever you please

Cons

• You need enough money in your account to buy the car in one go
• You don’t get any extra protection when paying in cash
• Dealers might not want to haggle on price

What car finance option is best for me?

In the current financial climate you need to be sure that you're making the best decision for you. Especially when it comes to an expensive item like a car.

Work out how much you'll use the car, how many miles you're likely to do, and whether you want to keep the car in the end.

How much does car finance cost?

This depends on several factors including:

• How much you want to borrow
• The length of the repayment agreement
• What interest rate (APR) you're offered
• Your credit rating
• Whether there are any fees added

The best way to work out how much you might pay for your car financing deal is to use our car finance calculator. Here you can get an idea of what your monthly repayments could be.

You have 2 options when using the car finance calculator:

• You know what you'd like your monthly payments to be, and want to see how much you could borrow
• You know how much you'd like to borrow and want to see what your monthly payments might be

Let's say you borrowed £6,500 over 60 months (5 years). In this scenario, the representative APR is 19.9%, with an annual interest rate of 19.9% (fixed) and a deposit of £0.

Your monthly repayments would be £166.07 a month. You'd be paying £3,464.37 in interest, meaning you're paying £9,964.37 in total.