Car Finance Guide

How car finance works

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A new car is always a big purchase, but luckily there are several ways to borrow the money you will need

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A car is one of the largest purchases most people will ever make. And when even budget options cost several thousand pounds, it can often be hard to gather the money together in one go.

This is where car finance comes in handy.

What is car finance?

Car finance is a catch-all term for a range of options that allow you either to borrow the money you need to buy a new or second-hand car, or lease it for a period before having the option to buy it outright.

You only need car finance when you don’t have enough cash to pay the full price for the car you want.

There are several ways to finance a car purchase, which all work in different ways. These are:

  • Car loan: You ask a loan provider to lend you enough money to make up the shortfall, and buy your car outright. You then pay the lender back in monthly instalments over an agreed period, adding pre-agreed interest
  • Hire purchase: This kind of agreement also sees you making monthly payments to a car finance company. The difference is that you’re paying to hire the car – and you’ll only own it after the final payment
  • Personal contract purchase: PCP plans have lower monthly repayments because you’re only paying a portion of the car’s value. You have the option to make a higher final payment at the end of the contract to keep the car, or you can return it and take out a new arrangement on a fresh car
  • Credit cards: Some people choose to buy cars on credit cards – as long as the car isn’t worth more than £30,000 and if the dealership allows. This is usually only a wise option if you have access to a card that has a long interest-free period on purchases, as most others tend to have quite high rates of interest

How does car finance work?

Even though each finance option ultimately sees you borrowing money from a lender to take possession of a new car, they all work in quite different ways, so it’s important to consider each one before you make your purchase.

You can normally use any of these options to buy either a new car or one that’s been pre-owned, but always check with the dealer and the lender first.

Buying a car with a personal loan

In many ways, using a loan to buy a car is the simplest option. Here are the important points:

  • It’s often a cheaper overall option in terms of how much you interest you pay
  • The car is yours to keep from the start
  • Loans can be arranged quickly, subject to credit checks, over the phone or online
  • The better your credit score, the better the interest rate you will be offered
  • You can choose how long you want to make repayments for, up to around five years
  • The more of your own money you use, the less you’ll have to pay back in the long run

Loans are also the only specific car finance option MoneySuperMarket offers.

Buying a car with a hire purchase

Hire purchase arrangements often cost you less up front, but they come with drawbacks. This is what you need to know:

  • Under a hire purchase agreement you make monthly repayments to hire the car, including interest
  • You don’t own the car until you make the final payment
  • Hire purchases are offered directly by the dealership, so they’re normally easy to arrange at the forecourt on the spot
  • They require a deposit of at least 10%, but your terms will be better with a higher down payment
  • Choose the length of repayment period you prefer, usually up to five years
  • Shorter-term hire purchases tend to be more expensive

Buying a car with a personal contract purchase (PCP)

This car finance deal is even cheaper up front, but they work out more expensive overall if you want to own your car at the end of the contract. These are the key points:

  • You take out a loan at the start, but it doesn’t cover the cost of the new car. Instead, it covers how much the lender thinks will be the difference between how much the car is worth new, and how much it will be worth at the end of the agreement
  • You pay a deposit and make monthly repayments with interest as above, which allow you to keep hiring the car
  • The deposit can start at 10%, with repayments made over one to four years
  • At the end of the contract, you have three options: trade the car in and start a new PCP, give the car back to the dealer and walk away, or make one final payment to keep the car (known as a balloon payment – you pay what the car is currently worth)
  • The balloon payment at the end can be quite expensive, especially if the car has kept its value
  • If you go over the agreed mileage or the car has a lot of wear and tear at the end, you’ll have to pay extra
  • This type of agreement is useful if you don’t mind giving up your car at the end – but it will be quite pricy if you want to keep it, considering the extra interest you’ll have paid along the way

Buying a car on a credit card

Credit cards are another option for car finance to consider. They work best as part of a cash purchase – if you buy a car entirely on credit, your eventual repayments are likely to end up very high.

  • The best type of credit card to use is a 0%-interest purchase credit card. These cards generally have decent periods where you don’t have to pay any interest on a big purchase at all
  • If you go past the interest-free period, however, you’ll generally come up against interest rates far higher than those you’d have got with a personal loan
  • If you make part of your purchase on a credit card, there are legal protections which will help you if anything goes wrong
  • You are protected up to a limit of £30,000, but the amount you’re actually able to spend will depend on the credit limit you’ve agreed with the card supplier, while the dealer may not allow you to put this much onto a card

Leasing your car

You can also lease your car using car finance. This type of arrangement lets you hire a new car for several years and return it at the end of the lease period – effectively a long-term car rental.

It works like the other hire purchase arrangements: you put up a deposit and make monthly payments. You can also add servicing plans to your deal for a little extra, to help guarantee you hand it back in good condition and avoid paying fines.

The main difference is that you don’t end up owning the car at the end.

Should you buy a car in cash if you can?

The short answer is yes – if you can afford it, it’s better to a buy a car with your own cash. Borrowing money costs you more in the long run in interest payments, and the interest you pay on any finance scheme will be more than the interest you earn from sticking your money into a savings account.

If you don’t have all the money, it’s worth stumping up as much as you can for the same reason. The smaller the loan you take out, or the larger the deposit you put down, the less you’ll pay over all.

Compare car loans

MoneySuperMarket works with a wide range of personal loan providers. If you want to finance a car purchase, you can compare loans and sort them by size, duration, interest rate and other options.

All you have to do is provide a few details about yourself, and we will perform what’s known as a soft credit check, which won’t harm your credit score, and show you which loans you are mostly likely to be accepted for.

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