4 main types of car finance
Car finance is a way to borrow money to buy or lease a car. It works like a loan in that you pay back set amounts (including interest) over an agreed period. Once your agreement is in place, you’ll drive away in the car and pay for it over time. Your finance agreement can be tailored depending on the size of your deposit, your credit history and how long you want the agreement to last (which could be around 1 to 7 years depending on the lender).
There are four main types of car finance in the UK:
1. Hire purchase
With hire purchase (HP) you pay an initial deposit followed by monthly repayments (including interest), which go towards repaying the full value of the car. Once you’ve paid the final instalment, you become the legal owner.
2. Personal contract purchase
With personal contract purchase (PCP) you pay a deposit and make monthly repayments (including interest). However, the payments tend to be lower compared to HP because you only pay the difference between the car’s initial price and its expected (lower) value at the end of the contract term.
Once your agreement term ends, you can either:
- pay the ‘balloon payment’ to become the legal owner
- or hand the vehicle back to the dealership at no extra cost.
3. Personal contract hire
Personal contract hire (PCH) is essentially a long-term rental agreement. You pay a deposit and make monthly payments for the use of the car, but there’s no option to purchase the vehicle at the end of the agreement.
4. Personal loan
If you take out a personal loan you can use the lump sum to purchase a car outright from a dealership or private seller. You then repay the borrowed amount in monthly instalments (including interest) to the loan provider.
How does your credit score affect car finance?
Your credit score reflects your credit history and can affect:
- whether you’re approved for car finance
- what options are available to you if you are approved, and
- the interest rates you’re offered.
The higher your credit score is, the better your chances of approval and with lower interest rates. This is because a high credit score indicates that you are good with money – and are therefore a low-risk, reliable borrower.
If you have bad credit, on the other hand, your finance options may be more limited. And If you’ve never taken out a credit card or a loan before, you may struggle to get accepted for car finance. This is because you’ll probably have what’s called a ‘thin credit history’ – which means lenders are unable to see how good you are at managing your debts.
Is there a minimum credit score to buy a car UK?
No, there’s no minimum credit score required to buy a car. However, the better your credit score is, the higher your chances of approval and with competitive interest rates.
Each lender will use their own eligibility criteria, and some may place more weight on your credit score than others.
However, if your score is looking low across all three of the main credit reference agencies in the UK (Experian, Equifax and TransUnion), then you may be less likely to be approved for car finance.
If you’re using your savings to buy a car, rather than opting for finance, then your credit score doesn’t matter, as the lender won’t need to carry out a credit check.
Can you get a car loan with a credit score of 600?
You may be able to get a car loan with a credit score of 600. It depends on which credit reference agency you are using (and which lender you’re applying to). Here’s why:
- with Equifax, a score of 600 would place you in the top category of ‘excellent’
- with Experian, 600 would place you in the ‘poor’ category
- with TransUnion, a score of 600 would put you in the medium category of ‘fair’
So, you can see from this just how much credit scores vary between agencies, which is why, there is no one universal credit score to be aiming for.
What credit score model do car dealerships use?
Different lenders will use different credit score models depending on their own eligibility criteria and which credit reference agency they use. So, there’s no one-size-fits-all credit score sought by lenders. But there are steps you can take to improve your credit score and chance of approval across the board.
How to improve your credit score
Building your credit score takes time and commitment, but there are some nifty tips to help you to boost your score quickly:
- add your name to bills – so your repayments show on your credit report
- set up direct debits – so you don’t forget to make regular payments
- join the Rental Exchange Initiative – this shows lenders you always pay your rent on time
- register to vote - this helps lenders to confirm your identity
- use savings to pay debts – this can save you money on interest
Read 5 ways to improve your credit score in 1 day for more details.
What else is considered?
Lenders don’t just look at your credit score when you apply for car finance. They consider a variety of other factors, based on the risk involved in lending to you. Here’s a breakdown of common factors:
1. Your credit history
Your credit history, as the name suggests, is a record of your past financial behaviour. Lenders use this as a method of predicting your future behaviour.
If you have a positive history of making your payments on time, lenders may see you as a responsible borrower who will continue this kind of behaviour. So, they should be more willing to lend to you.
Any public court records, like a County Court Judgement (CCJ) or bankruptcy, will show up on your credit history for six years. These negative markers could affect a lender’s decision about accepting you for car finance, as they suggest you’ve had issues dealing with debt in the past.
It’s also worth using an eligibility checker to see how likely you are to be approved before applying. Neither of these tools will impact your credit score.
2. Income and outgoings
Lenders will also look at your income and outgoings, to carry out affordability checks. They do this to make sure you can afford the loan repayments. It’s worth creating a budget by listing all your outgoings, so you can be sure that you can afford the loan too. If you don’t have enough left over after everything you have to pay, then it’s best not to apply for credit. If you can’t make your repayments, your credit score could be affected.
3. Debt-to-income ratio
Your debt-to-income ratio compares your monthly earnings with your debt repayments, usually expressed as a percentage. Lenders use this to assess your ability to manage monthly repayments. The lower this is, the more likely you are to be approved for a loan.
4. Credit utilisation ratio
Your credit utilisation ratio is a way of measuring how much of your available credit you’ve used. For example, if you have £2,000 available in credit and you’ve used £1,000, then your credit utilisation ratio will be 50%. Having lots of credit and hardly using it can work against you, but so can using all of it. The golden figure for lenders when it comes to credit utilisation is around 25% or less. This shows that you have credit, and you use it, but you don’t rely on it.
5. Your residential stability
Lenders will also look at your residential stability. If you’ve had lots of different addresses in a short space of time, this can make you seem less stable, which presents a risk to the lenders. They almost always ask for between three to five years of address history, so if you’ve moved around a lot in this time, it can work against you.
Do you need a good credit score to buy a car?
The bottom line is, while your credit score is by no means the only factor considered by lenders when you apply for credit, it is important, nonetheless. Your credit score reflects your credit history, which is what lenders are interested in when deciding whether to lend to you.
Remember, there’s no set score that means you’ll be approved for car finance because the number is just a guide. All lenders are different and lend to a variety of credit scores. So even if your credit score isn’t up to scratch, it may still be likely that you’ll be able to find car finance that works for you.
With that said, it’s worth taking a good look at your credit report to see if you can improve before you apply for car finance – as the best interest rates are typically saved for those with a healthier credit score.
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*Representative example: Borrowing £6,500 over 5 years with a representative APR of 20.7%, an annual interest rate of 20.7% (Fixed) and a deposit of £0.00, the amount payable would be £168.48 per month, with a total cost of credit of £3,608.67 and a total amount payable of £10,108.67. Rates may differ as they are dependent on individual circumstances. Subject to status. We're a credit broker, not a lender.