Whether you’re buying your first ever car or you’re in the market for a much-needed upgrade, deciding on how to finance a new set of wheels can be an overwhelming process. Like most high-value purchases, the ideal scenario would be to buy your motor outright, but this isn’t a viable option for many of us – which is why car loans can be such an attractive alternative.
However, taking out a loan to pay for your new car isn’t a decision to make lightly. From dealership finance to personal loans, there are a number of ways you can finance your purchase, so it’s important to do some research to ensure you get the best car loan to suit your needs. To help you along your way, we’ve put together a beginner’s car finance guide that takes a closer look at the different options available, along with the pros and cons of each.
What is car finance?
Also referred to as a car loan, car finance is, essentially, an amount of money borrowed over a fixed period that will pay for the purchase of a new or used vehicle.
Car finance is often available through car dealers, car brokers and car supermarkets, offering an affordable and convenient way for individuals to purchase a car without having to pay for it all at once. The finance is provided by an affiliated finance broker through the dealership at the time of purchasing the car, allowing you to pay a deposit on the car followed by monthly instalments to clear the remaining balance.
Within this bracket, there are three main types of dealership finance: hire purchase (HP), personal contract purchase (PCP) and personal leasing (contract hire). The loan terms will vary depending on the amount you wish to borrow, your personal financial status and credit rating, but typically they range from three to five years.
You can opt for shorter or longer terms depending on the broker, but shorter terms naturally come with higher monthly instalments – while a longer term will mean you’re paying a greater total value in the long run due to the ongoing interest.
An alternative to taking out car finance from a car dealer or broker is to opt for a personal car loan borrowed from an independent lender or bank. These types of loans are generally unsecured and can offer better lending terms – and they also mean you own the car from the outset. While the best rates are generally available to those with a good credit score, bad credit car loans are also available – but these come with higher interest rates due to a perceived higher level of risk in the eyes of lenders.
Dealership finance – what are the differences?
Dealership car loans are a popular and affordable choice if you’re looking to invest in a new set of wheels or upgrade your old car. However, it’s essential that you evaluate the different types of dealership finance to make sure you choose the most suitable option and, of course, a payment plan you can afford. Below you’ll find more in-depth information on what each option entails and the associated pros and cons.
Hire purchase (HP)
This type of car loan finance is taken out against the vehicle itself and essentially means you’re hiring it for the term of the lease – so you won’t be the car’s rightful owner until the full balance is paid off. As a result, you also won’t have the right to sell the car – which can be a disadvantage if you run into financial difficulties and can’t make the repayments, as the car will be repossessed to cover the cost of the loan.
With an HP agreement, you’ll be required to make an initial down payment or deposit, along with monthly instalments and interest for the entire loan repayment term to complete the purchase. Once the final payment has been made at the end of the loan agreement, you’ll then own the car outright – so this is ideal if you plan to hold onto the car for a long time.
Personal contract purchase (PCP)
An alternative to HP is a personal contract purchase, which generally involves you paying a deposit on the vehicle, followed by low monthly instalments over a fixed period of time. At the end of the contract term, you’ll then have to choose between paying off the remaining balance as a ‘balloon payment’ in order to assume full ownership of the car, returning the vehicle to the dealer or selling it privately to cover paying back the remainder of the loan.
This is often the most attractive solution for car owners who like to upgrade their vehicle every few years, as it provides greater flexibility. However, like an HP agreement, you still don’t own the car for the duration of the agreement and certain terms and conditions will apply. Before signing on the dotted line, be sure to check what the contract stipulations are, such as mileage limits, and keep it in good condition to avoid any issues further down the line – whether you decide to own the car outright, give it back or sell it to pay off the outstanding balance.
Personal leasing (contract hire)
Although similar to PCP in that you pay low monthly instalments to ‘hire’ the car for the term of the contract, personal leasing doesn’t provide you with the option to buy the car – you simply loan the car from the dealership. Having said that, these types of car finance deals make it easy to upgrade your car at the end of the contract, so it’s a great option if you like to regularly switch up your motor.
Naturally, the monthly instalment amounts will vary depending on the type of car, repayment term and mileage limit you agree, and will usually require you to pay at least three months’ rental upfront – so you’ll need some funds readily available.
An advantage of personal leasing is that servicing of the car is generally included – which can offset some of the running costs – but you may also be obliged to pay a large deposit for the privilege.
Personal car loans – the pros and cons
The most popular alternative to dealership finance is to take out a personal car loan from an independent lender to pay for your car. This comes with numerous benefits for those looking to pay for the car upfront and have full ownership from the get-go – as you’ll also have the freedom to sell the car when you want, and there are no limitations on mileage.
Another plus when it comes to taking out personal car finance is that you won’t be required to pay a hefty deposit and there’s greater flexibility on the loan repayment period. This means you can pay back the balance over a period that suits your circumstances, ensuring the monthly instalments aren’t going to be financially stretching for you. While APR rates on personal car loans tend to be higher than you’d find with dealership finance, it can still work out cheaper in the long run.
One of the disadvantages to owning your car outright through personal finance is that car values depreciate so quickly, meaning you may have to come to terms with the fact that the amount you pay back over the full term will be far greater than the vehicle’s actual value.
It’s also worth noting that the best car loans are awarded to those with good credit ratings, so, if you’re suffering from bad credit, you’ll likely be subject to higher interest rates. To know where you stand, it’s worthwhile obtaining a credit report to see if there are ways you can up your credit score and improve your chances of getting a good deal before you begin applying for car loans.
As with any application for credit, be mindful not to apply for too many over a short period of time, as this will appear on your credit report and flag up that you’re potentially a higher risk borrower.
Make informed decisions
Taking out a loan of any size comes with an element of risk, and car finance is no different. Before you venture into any financial agreement, be it with a dealership or a bank, you should be completely sure that you’re able to afford the payments and that you’re aware of all the applicable terms and conditions. That way, you can be confident that your new car is going to be a sound investment and not a financially crippling one.
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