What is car finance
Car finance can offer an affordable way to buy a new or used car. The term covers any credit agreement that helps you pay for a car by borrowing money.
You'll repay the loan over a period of time and pay interest on top.
Vehicle finance allows you to drive away in a car you may not be able to pay for upfront by spreading the cost with monthly repayments.
How does financing a car work?
There are different types of car finance; some products allow you to buy the car outright, which means you own the vehicle as soon as you sign. Other types of car finance mean you’ll only own your vehicle once you’ve made your final monthly repayment.
Depending on the type of car finance loan you choose, you can trade in your car at the end of the contract or keep it.
There are four main car finance options
- Personal Car Loan
- Hire Purchase (HP)
- Personal Contract Purchase (PCP)
- Personal Contract Hire (PCH)
What are the different types of car finance?
If you don't have the cash to buy a vehicle upfront, getting a car on finance may be worth considering. Whether you need an electric car or van finance, there are different car finance deals to suit different needs and budgets.
Here are some of the best car finance options to consider:
Personal car loan
This type of unsecured loan is the most widely available car finance option.
The interest rate is fixed, and repayments are made monthly over a set period - usually one to seven years. You can control how long it will take to repay the loan, but the longer you take, the more interest you'll pay.
A personal car loan is ideal if you have a good credit score and a regular income. Banks and direct lenders offer personal car loans, so it's a simple option if you want to own your vehicle outright immediately.
Personal contract purchase (PCP)
Personal contract purchase can be a cheap car finance option, to begin with, but the most costly overall if you want to own your car at the end of the contract.
You are initially hiring the vehicle, so you take out a loan at the start, but it will only cover the difference between how much the car is worth when it’s new and how much it's worth at the end of the agreement.
Like with a standard loan, you'll pay a deposit and repay monthly. The credit agreement will typically last between one and four years.
At the end of the contract, you'll have three options:
- exchange the car and start a new PCP
- pay to keep the vehicle (known as a balloon payment)
- give the car back to the dealer
Balloon payments are often pricey, especially if the car has kept its value, and you'll have to pay extra if you go over the agreed mileage.
Personal contract hire
Personal contract hire is also known as 'leasing', meaning you don't get to own the car outright. It's a cost-effective option if you only need a car for a short time.
As with other vehicle agreements, you'll pay a deposit upfront and make monthly repayments.
Upfront costs could be more expensive because you may have to pay up to three months' rental in advance and a large deposit or a service plan to cover the cost of wear and tear.
Hire purchase (HP)
A hire purchase agreement means you make monthly repayments to hire the car, including interest, so you only own it once you make the final payment.
You'll be required to pay a deposit of at least 10%, and the higher your deposit, the better your repayment terms will be. You can choose the repayment period length, usually up to five years.
Hire purchases are offered directly by the car dealer, so they're easy to arrange and done at the dealership on the day of purchase.
What is the best financing option for a car?
The best car finance deals will depend on several factors. Before signing up for new car finance, consider which borrowing options suit you and your financial circumstances.
When buying a car on finance, consider these questions to help you determine the best way to finance your vehicle:
- Do you want to own the vehicle outright?
- How much can you afford to pay each month?
- Do you want a new or used car?
- Do you want to upgrade your car often?
- How long will you need the vehicle
- How much can you afford to put down upfront?
Once you’ve researched the best car finance option for your circumstances, compare interest rates across different providers by looking for the representative APR and check the small print for additional fees for things like wear and tear or exceeding the agreed mileage.
To ensure that you're getting the best deal to finance your car purchase, it's important to use a comparison site like ours to compare car finance options with personal loans.
How much will car finance cost?
It depends on the type of car finance and the interest rate the car finance provider or lender offers you.
Personal car loans are the easiest to estimate because you can use an online loan calculator to find out how much your monthly repayments are likely to be.
Personal Contract Hire or Hire Purchase costs are often more complex but may include the following:
- a deposit
- monthly instalments + interest
- final or balloon payments
There could also be additional charges if you need to pay for servicing and motor repairs or exceed the agreed mileage.
What do you need to qualify for car finance?
Some car finance companies have specific lending criteria, but typically, to be eligible for car finance, you must:
- Be 18 or over
- Be a UK resident
- Have a regular income
- Have a UK current account
The car finance provider will also carry out affordability and credit checks to determine whether you are creditworthy and can afford to repay the loan.
What are the pros and cons of financing a car?
Borrowing money for any purchase comes with risks, so weighing up the advantages and disadvantages before using car finance to buy a vehicle is important.
Here are some pros and cons of financing a car with a personal contract or a hire agreement:
- You can drive now, pay later
- Can be arranged with the dealership
- Monthly repayments are more manageable
- Option to only borrow part of the purchase price
- Swap or upgrade your car regularly
- No need to worry about depreciation
- Save while you hire the car
- You don't own the vehicle until the contract comes to an end
- A minimum deposit is usually required
- Mileage restrictions may apply
- Monthly repayments could be higher than a loan
- possibility of negative equity
- PCP may require a balloon payment or lump sum
- If you damage the car over the loan period, you will still have to pay back the loan or keep up with the repayments, even if the vehicle has been written off
Car finance FAQs
You'll need to provide personal ID and other types of evidence to support your application, such as:
- Driving licence
- Proof of income, such as wage slips or bank statements
- Your UK residence and address history for the past three years
- Employment details
- Account number and sort code ready to accept a direct debit
Taking out any new forms of credit can temporarily reduce your credit score because a hard credit check will be left on your credit report. Multiple applications for credit within six months can harm your credit rating.
If you make your car finance repayments in full and on time, your credit rating can improve.
By using a comparison site, you can compare personal loans to finance your car purchase without worrying about affecting your credit score.
Comparison sites like ours do this by assessing your eligibility and indicating the loan providers who are most likely to approve your loan application, thereby minimising the need for you to submit multiple credit applications.
Yes, it's possible, but getting approved may be more challenging, and it’s likely to cost you more than someone with a good credit score.
You can take steps to improve your credit score before applying; for example, by clearing any outstanding debts you may have, making sure you’re registered on the electoral roll and keeping any credit card balances under 25% of your limit.
Once you've boosted your credit rating, you'll have a greater chance of being accepted for car finance.
If you've bought your vehicle with a personal car loan, you own the car outright immediately and can sell it whenever you wish. However, different rules apply if you've bought your vehicle with a personal contract or hire purchase agreement.
You can sell your vehicle on car finance if you fully repay the loan, including any final balloon payment and additional fees.
However, if you want to sell the car midway through your Personal Contract Purchase agreement, you must settle the loan first. Once the settlement figure is paid, you're the car's legal owner, which allows you to sell it privately or to a car dealership.
With a car bought with a Hire Purchase arrangement, the car finance company owns the vehicle until all repayments have been made. To sell the car, you'd need to settle the debt with the creditor before selling the vehicle.
Yes, it's possible, but there are pros and cons. You'll save money on interest payments and become the legal owner of your car more quickly if you bought it on a PCP or HP arrangement. However, you'll need a sizeable amount of cash to pay the settlement figure, and you may also have to pay early repayment fees.