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What is car finance?

Simply put, car finance is a way to borrow money to buy a car. It’s a type of loan, so you’ll borrow an amount and pay it back in monthly instalments. There are a few types of car finance, such as hire purchase (HP) or personal contract purchase (PCP), so it’s best to find the right one for you.

5 min read
car salesperson talking to a buyer

How does financing a car work?

Financing a car works by borrowing a set amount of money, obtaining the vehicle and then paying it back in monthly instalments. There are many ways to do this, depending on the size of the deposit you have, your credit history and your personal preferences. But fundamentally, it works the same way as taking out any loan. You’ll do your research, apply and if accepted, an agreement will be put in place.

What types of car finance are available?

There are several ways to borrow money for a new car, some popular options include:

Hire Purchase

Hire purchase is a relatively simple form of loan. Generally, you pay a deposit, then pay monthly instalments for up to five years (including interest) and at the end of the agreement, you own the car outright.

You can get hire purchase agreements from dealerships and finance brokers, online and in person.

PCP

PCP stands for personal contact purchase and it’s also a type of loan - but you don’t borrow the full cost of the vehicle. You can get PCP agreements from finance brokers and dealerships, for new and sometimes used cars.

Generally, you pay a deposit, borrow a set amount, pay back monthly instalments over three to five years - then you’re given the option at the end to pay the remainder of the balance, in order to own the car outright.

If you don’t want to make the final payment (often called a balloon payment), you can just return the car. Many people who like to change their car regularly prefer a PCP option, as they can hand the car back and start a new agreement every few years.

PCH

PCH stands for personal contract hire. This is effectively a long-term rental agreement, so you don’t ever own the car.

You pay a deposit, then pay monthly instalments for the duration of your use. You then hand the car back at the end of your term, with no option to buy the vehicle.

Personal Loan

You can also take out a personal loan to buy a car. This is money you borrow as a lump sum and pay back in monthly instalments, including interest. You can generally arrange personal loan terms from one year up to about five years (sometimes longer).

You’ll take out the loan through a bank, lender or broker, then use the cash to purchase the car outright. You’ll own the car from the get-go and you can buy from a dealership or a private sale.

A personal loan is also known as an unsecured loan, which means it isn’t secured against anything you own (like your home). It’s also not secured against the car. Therefore, interest rates can often be higher than other types of finance. It’s also worth noting that the best rates are often reserved for those with stronger credit scores.

What are the alternatives to car finance?

If you’re unsure about the car finance options above, you could consider these solutions instead:

Buying outright

If you’re not purchasing a car on finance, it’s likely you’re considering buying outright.

If you have the funds, you can purchase a car and pay the full amount at once. This is often a popular option for used cars, where the cost is significantly lower than a new vehicle. You can also look for cars being sold privately if you’re buying outright on websites like Auto Trader or even on eBay.

Secured loan

An alternative to a personal loan is a secured loan to buy a new car. This is money you borrow that is secured against an asset you own, like your home, so you must be a homeowner to be eligible.

As the money is secured against an asset, the interest rates tend to be lower than a personal loan. But remember, your home will be at risk if you don’t keep up with the repayments.

Credit card

Another way you could borrow money for a new car is with a credit card. You’d be able to take out the card, purchase the vehicle on the card and then repay your credit card bill monthly. However, this does come with some considerations.

While a credit card can be a great tool for certain circumstances, it might not be right for this situation. The best way to use a credit card is to pay back the balance in full each month, to avoid interest and to improve (or maintain) your credit score. It’s unlikely you’d be able to pay back the balance in full for this type of purchase.

Another thing to bear in mind is your credit utilisation. Staying below 30% of your credit card limit is great for boosting your credit score, but unless you have an exceptionally high limit, a car is likely to take you over that (and keep your balance over that for a long-time).

For buying a car, it could be better to use an option specifically created for that purpose (like PCP, HP or a personal loan). You could save credit card use for more suitable situations - like having access to credit in an emergency or for credit-building.

Five tips to get the best deal on your car finance

1. Shop around - Compare deals from online car finance brokers, dealerships and personal loan brokers. Comparing products can help you find the best deal and ensure you don’t overspend

2. Consider your own financial situation - Think about your own circumstances when deciding. Do you have a lump sum to buy outright instead? How is your credit score looking? What size monthly repayment can you afford? Do you have a deposit ready? These factors should help narrow down which finance option suits you best

3. Think about what’s important to you - Generally, newer cars tend to be more reliable than older models, so if this is super important to you, you might want to consider getting a car on finance. Alternatively, if you’re happy with the risk of a used car (or you know a great local mechanic!) you might decide to buy a used car outright, to avoid paying monthly

4. Look into models that hold their value - Do your research and see which makes and models tend to retain value better. Cars lose value very quickly (as soon as you drive them off the forecourt), so find one that will be better value in the long run and you’ll get a stronger deal on finance

5. Choose the best time of year - Car sales professionals often have targets to meet, so it’s commonly believed that the end of each quarter is when you’ll get the best offers. This would be March, June, September and December

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*Representative example: Borrowing £6,500 over 5 years with a representative APR of 21.9%, an annual interest rate of 21.9% (Fixed) and a deposit of £0.00, the amount payable would be £172.09 per month, with a total cost of credit of £3,825.54 and a total amount payable of £10,325.54. Rates may differ as they are dependent on individual circumstances. Subject to status. We're a credit broker, not a lender. **See our cashback offer T&Cs