The pros and cons of car finance

Is car finance a good idea?

It can be, if you need a car now, can comfortably afford the monthly payments and don't have the cash to buy outright.

That said, it isn't the cheapest way to buy a car. If you've got the money saved, paying outright means no interest, no monthly payments, and no impact on your credit score. The car's yours from the start, so you're free to modify, paint, or sell it whenever you like.

The downside is that you're limited to what your savings can cover. It could also leave you with less of a safety net for unexpected costs.

What are the main types of car finance?

There are three main ways to pay for a car on finance: hire purchase (HP), personal contract purchase (PCP) and a personal loan. Each one works a little differently, so the pros and cons depend on which you go for.

Hire purchase (HP)

You pay a deposit, then fixed monthly payments. Once you've made the last payment and paid any 'option to purchase' fee, the car is all yours. Monthly payments tend to be higher than PCP, as you're paying off the full cost of the car.

Personal contract purchase (PCP)

Your monthly payments are usually lower, as they mainly cover how much value the car is expected to lose rather than its full price. When your deal ends, you can hand the car back, make a final 'balloon payment' to keep it, or use any value left as a deposit on your next car.

Personal loan

You borrow the money and buy the car outright, so it's yours from day one. Personal loans are usually unsecured, which means the car isn't tied to the loan. You may need a good credit score to get the best rates, though.

Advantages of car finance

Car finance has plenty going for it, especially if you don't have the money to buy a car outright.

Spread the cost

The biggest plus is that you can split the cost of a car into monthly payments over a few years. There's no need to empty your savings or put your plans on hold while you save up. Some lenders don't ask for a deposit at all, while others may ask for around 10% upfront.

Get a newer, more reliable car

Spreading the cost could help you afford a newer car than your savings alone would stretch to. A newer car is likely to have less wear and tear, so it may break down less often. That's a real weight off your mind if you rely on your car often.

Know what you'll pay each month

Most HP, PCP and personal loan deals come with a fixed interest rate, so your monthly payment stays the same for the whole agreement. Knowing exactly what's going out each month makes budgeting much easier.

Build your credit history

Paying your car finance on time every month can help build your credit history. It shows lenders you can handle borrowing well, which could help next time you apply for credit.

Hand the car back if you need to

With HP and PCP, you have a legal right to end your agreement early and hand the car back once you've paid half the total amount payable, including interest and fees. This is called voluntary termination. You can still return the car early if you haven't made 50% of ther repayments, you will just need to make the additional payment to take it to halfway first. You'll need to have looked after the car, and you may have to pay for any damage beyond normal wear and tear.

With PCP, you can also hand the car back at the end without making the balloon payment. So, you can simply walk away, with no need to sell the car or worry about how much value it's lost.

Disadvantages of car finance

Car finance isn't right for everyone, and there are a few downsides to weigh up before you decide.

You'll usually pay more overall

Because you're paying interest, car finance almost always costs more than buying a car with cash. The rate you're offered will depend on things like your credit history and the lender. Generally, the better your credit score, the lower your APR.

It's also worth knowing that with PCP, you pay interest on the full amount you borrow, including the balloon payment, even though your monthly payments don't cover it. So, if you're planning to keep the car at the end, PCP can work out more expensive than HP.

Payments can stretch your budget

Even spread out, car finance payments can take up a fair chunk of your monthly money, and that's before insurance, fuel, road tax, servicing and MOTs. It's a good idea to think about whether you could still manage the payments if you had an unexpected bill or your income dropped.

You won't own the car straight away

With HP and PCP, the car belongs to the finance company until you've made the final payment. You'll be the registered keeper and responsible for looking after it, but you can't sell it until the finance is paid off. You'll also usually need the finance company's OK before making changes, like fitting a new sound system or giving it a new paint job. This doesn't apply if you buy with a personal loan.

Mileage limits and wear-and-tear charges

With some types of car finance, like PCP, you'll agree a mileage limit at the start. Go over it and you'll usually pay a charge for every extra mile. You may also have to pay if the car has more than normal wear and tear when you hand it back.

You could owe more than the car is worth

Cars lose value over time, and sometimes that happens faster than you pay off your finance. If you owe more than the car's worth, this is called negative equity. It can make it trickier to switch cars before your deal ends. And if the car is written off, your insurance payout might not cover everything you still owe.

Missed payments can affect your credit score

Missing payments will show up on your credit report and could lower your credit score. With HP and PCP, the finance company could also take the car back if you keep missing payments. If you're worried about keeping up, try to speak to your lender as soon as you can. They have to treat you fairly and may be able to help.

How to get the best car finance deal

The best deal is the one that suits your budget and how you'll use the car, not just the one with the lowest monthly payment. A few things that can help:

• Look at the total amount you'll pay back, not just the monthly cost.
• Check the APR and any fees, such as arrangement or option to purchase fees.
• Put down a bigger deposit if you can, so you borrow less.
• Choose a term that keeps payments comfortable, but bear in mind that a longer term usually means paying more interest overall.
• Use a broker that works with lots of lenders, so you can compare more deals in one go.

Can I get car finance with bad credit?

Yes, you may still be able to get car finance with bad credit, as some lenders specialise in helping people whose credit history isn't perfect. You might be offered a higher interest rate or asked for a bigger deposit. Checking your eligibility first can give you an idea of your chances without affecting your credit score.

Which type of car finance might suit you?

The right type of car finance depends on what matters most to you. As a rough guide:

• HP might suit you if you want to own the car at the end and keep it for a good few years.
• PCP might suit you if you'd like lower monthly payments and like the idea of changing your car every few years.
• A personal loan might suit you if you want the car to be yours from day one, with no mileage limits or restrictions.

Whichever you go for, make sure the payments fit comfortably in your budget, both now and further down the road.