Buying a car is a major financial decision, and for many drivers, paying for it outright isn’t the only option. Car finance can spread the cost into manageable monthly payments, but different types of finance work in very different ways.
Understanding how car finance works is important before committing to an agreement. Whether you’re buying a new car or a used car, understanding the agreement before you sign is essential. You need to look beyond the monthly payment and consider the deposit, interest, total amount payable, contract length, mileage restrictions and any final payment.
This complete guide to car finance explains the main options available in the UK, what to look for in a finance agreement and what to do if your application is rejected or you later need to end the agreement early.
There are several ways to finance a vehicle, and the right choice depends on whether you want to own the car, how much you can afford each month and how long you intend to keep it.
The most common options include Hire Purchase, Personal Contract Purchase, personal loans and leasing.
Hire Purchase (HP) is one of the more straightforward forms of car finance.
You’ll normally pay a deposit followed by a series of monthly payments. These payments cover the cost of the vehicle plus interest. Once you’ve made all the required payments and paid the final option-to-purchase fee, ownership of the car transfers to you.
HP generally has higher monthly payments than PCP because you’re paying towards the full cost of the vehicle rather than leaving a large balloon payment until the end.
However, there is usually no large final balloon payment, which can make HP easier to budget for if you want to own the car at the end.
MoneyHelper’s guide to Hire Purchase explains how HP works and what to consider before signing an agreement.
Personal Contract Purchase (PCP) is another popular form of car finance.
You’ll normally pay a deposit followed by monthly payments over an agreed period. The payments are lower than they would be with HP because part of the vehicle’s expected future value is left until the end of the agreement as a balloon payment.
At the end of a PCP agreement, you generally have three main choices:
PCP agreements normally include an agreed annual mileage allowance. Exceeding that allowance can result in additional charges if you return the vehicle.
You’ll also need to consider the condition of the car. Excessive damage beyond what is considered fair wear and tear can result in charges when the vehicle is returned.
PCP can therefore provide lower monthly payments, but it is important not to judge the deal solely on that figure.
MoneyHelper’s PCP car finance guide provides further information about deposits, balloon payments, mileage limits and your options at the end of the agreement.
A personal loan is another way to pay for a car.
Instead of the finance being arranged against the vehicle, you borrow money from a lender and use it to purchase the car. The loan is then repaid in fixed instalments over an agreed period.
One potential advantage is that you own the vehicle from the outset, assuming the loan is unsecured and the purchase is completed normally.
However, you’ll still need to consider the interest rate, loan term and total amount you’ll repay.
A longer loan term can reduce the monthly payment but may increase the total interest paid, so it’s important to compare the overall cost rather than simply choosing the lowest monthly figure.
Leasing, often known as Personal Contract Hire (PCH), is another option if owning the vehicle isn’t important to you.
You’ll normally make an initial payment followed by monthly payments for an agreed period. At the end of the lease, the vehicle is returned rather than becoming yours.
Leasing agreements can have mileage limits and conditions relating to the vehicle’s condition when it is returned.
This can be attractive if you like changing cars regularly and don’t want to worry about selling the vehicle at the end of the agreement.
However, you won’t own the car and won’t normally have the option to buy it through a standard PCH agreement.
One of the biggest mistakes when considering car finance is concentrating too heavily on the monthly payment.
A deal advertised with a low monthly figure can still cost considerably more overall once you include the deposit, interest and final payment.
When comparing car finance agreements, look at:
APR is useful for comparing the cost of borrowing, but it shouldn’t be considered in isolation. The total amount payable is another important figure to check before committing.
The Financial Conduct Authority’s consumer credit guidance provides further information about creditworthiness, affordability and consumer credit.
Before applying for car finance, it’s sensible to check your credit report and make sure the information held about you is accurate.
Your credit history can affect the finance products available to you and the interest rate you may be offered. However, there isn’t a single universal credit score used by every lender, so don’t assume that one particular score guarantees approval or a particular rate.
It’s also important to understand whether a finance application involves a hard credit search. A hard search can appear on your credit file, whereas some eligibility checks may use a soft search that doesn’t have the same effect.
If you’re comparing finance options, ask whether an initial eligibility check uses a soft or hard search where this isn’t clear.
Checking your credit report before applying can also give you the opportunity to correct errors before you make a full application.
Before choosing a car, work out how much you can comfortably afford.
Don’t base your budget solely on the monthly finance payment. Owning a car involves several other ongoing costs, including:
Your car finance payment should remain affordable alongside your other monthly costs.
You should also consider unexpected costs. A finance payment that looks affordable on paper can become difficult to manage if you have an expensive repair or another change in your finances.
A good starting point is to list your regular income and essential expenditure before deciding how much you can comfortably put towards a vehicle.
A larger deposit can reduce the amount you need to borrow and may reduce your monthly payments.
However, don’t use every penny of your savings simply to reduce the finance payment. Keeping some money available for emergencies can be important.
The right deposit is therefore about balancing the cost of borrowing with your wider financial situation.
Once you’ve established your budget, you can start looking for a vehicle that fits your needs.
If you’re considering a used vehicle, you can browse used cars for sale on MotorHype.
Before committing to a purchase, make sure you research the vehicle itself as well as the finance. Running costs, insurance, fuel economy, reliability and depreciation can all affect the overall cost of ownership.
Our guide on how to buy a used car safely is also worth reading if you’re considering a used vehicle.
Once you’ve found a car and decided which finance option you want to explore, you’ll normally need to provide information for the application.
Depending on the lender, you may need details such as:
The exact information required varies between lenders.
Providing accurate information is important. Never exaggerate your income or provide incorrect details simply to try to improve your chances of being accepted.
You can apply for finance through a dealership, finance broker, bank or other lender, depending on the type of agreement you’re considering.
The lender will assess your application and consider factors such as your credit history, income, existing commitments and ability to afford the repayments.
Being approved for a particular amount doesn’t necessarily mean you should borrow the maximum available. Your own budget should determine how much you spend.
If your application is approved, don’t feel pressured to accept the agreement immediately.
Take time to read the paperwork and make sure you understand exactly what you’re agreeing to.
Pay particular attention to:
If a dealer offers optional extras such as warranties, breakdown cover or GAP insurance, make sure you understand what you’re paying for and whether you actually need them.
The cheapest monthly payment isn’t necessarily the cheapest finance deal.
Being rejected for car finance doesn’t necessarily mean you won’t be able to buy a car.
There can be many reasons why an application isn’t accepted, including affordability, credit history, existing commitments or the lender’s own criteria.
If your application is rejected, avoid immediately making several more applications without understanding why.
Instead, consider:
Be particularly careful with finance marketed towards people with poor credit. A higher acceptance rate can come with a significantly higher cost of borrowing.
You may be able to end a finance agreement early, but the rules depend on the type of agreement and how much you’ve already paid.
If you’re considering ending a PCP or HP agreement, contact the finance provider first and ask about your options.
You may be able to request an early settlement figure, allowing you to pay off the remaining balance and keep the vehicle. The amount required can be different from simply adding together all the remaining monthly payments.
MoneyHelper explains the different options in its guide to ending car finance early.
If you have a regulated HP or PCP agreement, you may have a legal right to voluntarily terminate it once you’ve paid, or can pay, 50% of the total amount payable under the agreement.
Importantly, with PCP, the 50% figure can include the large balloon payment at the end of the agreement. This means you may need to have paid considerably more in monthly instalments than you initially expected before reaching the 50% point.
If you voluntarily terminate the agreement, you normally return the vehicle to the finance company and won’t receive money back simply because you’ve paid more than 50%.
The exact circumstances matter, so check your agreement and speak to the finance provider before taking action.
If you’re struggling to keep up with your monthly payments, contact the finance provider as soon as possible.
Don’t simply stop paying.
The lender may be able to discuss options with you, such as changing the repayment arrangement or extending the term. The options available will depend on your agreement and circumstances.
Missing payments can negatively affect your credit file and may lead to further action, so dealing with the problem early is important.
If you’re experiencing wider financial difficulties, consider seeking independent debt advice rather than taking out further credit to cover existing payments.
If you’re buying a car from a private seller, the finance options are more limited.
A standard PCP or HP agreement generally isn’t available in the same way as when buying through a dealer. You may instead need to use savings or arrange a personal loan or another form of credit to pay the seller.
If you’re buying privately, take extra care with the vehicle’s history, ownership and payment arrangements.
Never transfer money simply because a seller is putting pressure on you to complete the deal quickly.
Our guide to how to pay for a used car from a private seller covers the safest ways to approach payment.
If you’re dealing with a lender or broker you’re unfamiliar with, make sure you’re comfortable that you’re dealing with a genuine regulated firm.
The FCA provides information about authorised firms and has a current list of car finance lenders and complaint contacts.
It’s also worth keeping copies of the finance agreement and any important documents you receive.
Car finance can make a vehicle more affordable in the short term by spreading the cost over several years, but it isn’t automatically the cheapest way to buy a car.
HP can be attractive if you want straightforward ownership at the end of the agreement.
PCP can offer lower monthly payments and flexibility at the end, but the balloon payment, mileage restrictions and condition requirements need to be understood.
A personal loan can give you ownership of the vehicle from the outset, while leasing can suit drivers who prefer changing cars regularly without owning them.
The best car finance option depends on your circumstances, how long you want to keep the vehicle and how much you’re comfortable paying overall.
Car finance can be a useful way to spread the cost of buying a vehicle, but the monthly payment should only be one part of your decision.
Before signing an agreement, understand the deposit, APR, total amount payable, contract length, final payment and any restrictions that apply.
It’s also important to budget for the wider costs of running the car and make sure the repayments remain affordable if your circumstances change.
Choosing the right car finance agreement means looking at the overall cost rather than simply the monthly payment.
Take your time, compare the options and don’t be afraid to walk away from a deal you don’t fully understand.
If you’re ready to explore your options, you can find car finance deals and compare what’s available to you.
If you’re ready to start looking for your next vehicle, browse our used cars for sale and make sure you choose a car that works for both your needs and your budget.
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