Like most high-value purchases, the ideal scenario would be to buy your motor outright – however, this isn’t a viable option for many of us, which is why personal car loans and car finance deals 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?
Commonly referred to as a car loan or car finance, it’s 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 3 to 5 years.
You can opt for shorter or longer terms depending on the broker, but shorter terms naturally come with higher monthly instalments . In contrast, a longer term will mean you pay back a smaller amount of interest every month, but the total interest payable at the end of your term will be far greater.
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.
Example – After getting rid of her old and trusty banger, Hannah is in the market for a new car. The car will cost her £10,000 and she already has £2,500 in her savings that she’s looking to put down as her deposit. As a result, she will need to borrow £7,500 and would like to pay back this amount over a 4 year period. She boasts a good credit score and has been offered a 3.9% fixed annual interest rate with a representative APR (annual percentage rate) of 3.9% – meaning that her total monthly repayments would be £168.78, every month for 48 months. This means that Hannah’s total cost of credit would be £601.44 over the 4 year period and she’d pay back a total of £8,101.44 at the end of the term.
Understanding your options
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 comfortably afford. Below, you’ll find more in-depth information on what each option entails and the associated pros and cons of each.
While a personal loan isn’t specifically designed to be used to take out money for a car, due to the wide range of uses this type of loan can be used for (weddings and holidays to name a few), it can be an effective and versatile option for those looking to buy a car outright. Personal loans are usually unsecured – meaning that none of your assets are secured against the loan and, subsequently, none of your personal assets will ever be at risk of repossession.
Personal loans are typically borrowed from a bank, credit union, private business or lender, however due to their unsecured status, lenders are typically more apprehensive about offering them out. This means that interest rates are often higher, particularly in cases where the borrower’s credit score is poor.
Generally, you can borrow up to £25,000 with a personal loan, although this is of course dependent on exterior factors such as your credit history and what you’d like to use the loan for. If you choose to take out a personal loan this means that you’ll be able to pay for the vehicle outright, allowing you to sell it on if and when you wanted to.
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 at the end of the agreed term. 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 (typically around 10% of the car’s value), 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. This generally involves you paying a deposit on the vehicle, followed by low monthly instalments over a fixed period of time that total the cost of the vehicle at its depreciated value (what it would be worth after your loan period) . At the end of the contract term, you’ll then have to choose between paying off the remaining balance as a ‘balloon payment’ (the outstanding sum made at the end of a loan period) 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 at the end of the loan term – 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 of rental upfront – so you’ll need some funds readily available before taking out a contract hire car.
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.
It’s also worth noting that the best personal car loans and car financing deals 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.
Things to consider
- Your spending habits: First thing’s first when looking at car financing options – you need to be realistic about the kind of money you can commit towards paying for a car in the long-term. In essence, this means that not only do you need to consider the affordability of immediate costs, but also whether your spending habits can incorporate the added monthly expense of repayments
- Your choice of car: It’s worth considering whether there’s a difference between the type of car you initially set your eyes on versus a more expensive car that you only begin paying attention to once you decide you’ll be taking out a loan. this. Be realistic with your car options and remember that paying for the car is just one hurdle – after the keys are in your hands, there’s still the insurance, fuel and maintenance costs attached to the vehicle. This could quickly see you in more debt than you originally budgeted for. You should also consider how long you need the car for, as this could help you decide between the types of loan or model of car
- Soft searches: When looking for any type of loan or financing option, it’s best practice to avoid making numerous applications and enquiries until you’re sure that you’re likely to be accepted. Soft searches are an effective option that allow you to look into different types of loans without affecting your credit score – they’ll let you know how eligible you are for particular types of loan to help you make a more informed decision
- Contractual obligations and limits: If you end up opting to lease a car, there may be certain rules you have to commit to in order to not face any unexpected charges at the end of your lease term. For example, many lease contracts will prohibit you from exceeding a certain number of miles per year, known as a mileage allowance. Not adhering to this allowance may result in additional charges of unanticipated fines should you wish to hand your car back in at the end of the agreed lease period
- Shop around: What you believe to be a good deal may not be elsewhere. Therefore, don’t just take out a loan with the first dealership you come across just because you might have fallen in love with the car. Explore your options and compare different lenders and different vehicles to ensure you’re getting the best deal available
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.
To find out more about personal finance solutions, saving tips and more, visit our blog, where you’ll find up-to-date finance tips and news articles to help you make truly informed financial decisions tailored to your personal circumstances.
If you’re struggling with your personal finances, remember that there is help available. For more information, check out the Citizens Advice website here, or call the free national debt helpline on 0808 808 4000.