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How car finance works

Understand the options for financing your car

With so many finance choices available, thinking about how you’ll pay for that new set of wheels can be confusing. Our guide explains car finance so you can decide which option is right for you...

By Lucy Hancock

Published: 12 November 2021

Man driving

 

 

 

Funding a new car can be expensive, especially if you choose to pay upfront. But if you don’t have the cash saved to buy the car outright, there are several finance options available. That’s where car finance comes in. By using credit you can make your new wheels feel more affordable by spreading out the cost in instalments over time.

What is car finance? 

Car finance is a catch-all term for a range of options that allow you 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. 

How does buying a car on finance work? 

Whatever car finance option you choose, it will always involve borrowing money from a lender to cover the cost of a new car. But there are plenty of different ways of doing this, and they all work differently. It’s important to consider the pros and cons of each car finance option. 

You should be able to 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.

 

Car loans

If you can’t afford to buy a car outright, a car loan can be a cheaper way to borrow than other types of car finance if you have a good credit score and can get a low rate deal. Using a loan to buy a car works like this:   

  • You’ll choose the amount you need to borrow and how long you want to borrow it for (the term)

  • If your loan is accepted, the bank will pay the money directly to your bank account so you can buy the car 

  • From there, you’ll pay off the loan instalments back to the provider

  • You’ll own the car from the moment you buy it - car loans are unsecured, which means the car is yours, not your lender’s 

Personal contract purchase

With a personal contract purchase plan - usually known as a PCP, your monthly repayments are often smaller than with a car loan. But if you want to keep the car at the end of the contract, there are likely to be extra costs. Here’s how a PCP works:  

  • You take out a loan at the start, but it doesn’t cover the full cost of the new car. Instead, it'll cover the depreciation of the car – that is, how much the lender thinks the car will fall in value compared to its value brand new 

  • Pay a small deposit (typically 10%) and make monthly repayments with interest – the term of the PCP will usually range from one year to four years  

  • At the end of the contract, you’ll have three options: trade the car in and start a new PCP plan on a new car, 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 the difference in the outstanding balance up to what the car is currently worth 

  • The balloon payment at the end can be expensive, especially if the car has held its value 

  • If you go over the agreed mileage or the car has a lot of wear and tear at the end, you’ll also have to pay extra 

Hire purchase 

With a hire purchase, or HP plan, you’ll make monthly payments to a car finance company. The difference is that you’re technically paying to hire the car – and you’ll only own the vehicle after the final payment. It’s often cheaper than other options, but there are some drawbacks. Here’s how it works:

  • Under a hire purchase agreement you make monthly repayments to hire the car – this includes the loan and interest 

  • Hire purchases are offered directly by the dealership, so they’re usually easy to arrange

  • They often (but not always) require a deposit of around 10%, but your terms may be better the bigger the deposit you can put down 

  • Choose the length of repayment period you prefer, usually up to five years

  • Shorter-term hire purchase plans tend to be more expensive 

  • Once you’ve made the final payment, the car is yours 

Car leasing 

Another option is to lease your car using finance – this is also known as personal contract hire, or PCH. This means you hire a new car for several years, returning it at the end of the lease period (essentially a long-term car rental).

Like other hire purchase agreements, you’ll usually put a deposit down and make monthly repayments. You’ll also be able to add servicing plans to your deal – for an add-on cost, to ensure you hand the car back in good condition and avoid paying fines. The main difference is you won’t end up owning the car at the end of the deal so there’s no way you can make some of your money back by reselling it. 

What is the best car finance option for me?

The best finance option for you will depend on your personal situation. When you’re deciding which type of car finance works best for you, there are a few things you should consider:  

  • Are you looking for a new or used car? You might have different finance options if your car has been pre-owned. With a car loan you can use the funds to buy new or used, whereas with a PCP deal or leasing contract you’re more likely to use it to fund a new car purchase

  • How strong is your credit score? With better credit, you’ll be eligible for more deals – and you’ll get better interest rates too. This might make a personal loan a more cost-effective way to purchase a car, compared to other types of finance. If you have a weaker credit score alternative types of car finance, such as hire purchase, could be cheaper 

  • Would you prefer to have higher monthly repayments but own your car outright, or pay less each month but not own your car until the end of the deal term? With a loan you’ll own your car from day one when you pay for it, where in contrast with a PCP deal or with leasing you won’t own the car for the duration of the plan

  • Will you want to sell your car at the end of your deal, or are you happy to lease it for a few years then hand it back or swap for a new contract? Car loans and hire purchase arrangements work best if you want to own the car  

  • How do you plan on using your car? Remember, some finance options, such as PCP deals, set limits on your mileage

If you’re not sure what kind of option is best for you, it helps to get a better picture of what’s on offer and the relative costs. Try comparing quotes to see what’s out there – and remember searching with us won’t affect your credit score in any way.  

 

 

Can I get car finance with bad credit? 

Lenders will look at your credit history and score when deciding whether or not to lend to you.  Unfortunately, if your credit history isn’t great and you have a low credit score, you might not have access to the best deals, and you’ll usually be charged higher rates of interest.

The same goes for PCP and HP plans. Dealers will always look at your credit history before offering you a finance contract and they’ll reserve their top deals (with the keenest interest rates) for those with high credit scores.  

That said, bad credit doesn’t have to be an instant ‘no’ when it comes to car finance. Here at MoneySuperMarket we work with specialists in car finance for bad credit, and may be able to match you with the right car loan. 

How does 0% car finance work? 

0% APR finance deal means you’ll spread the cost of the car over a set period, making monthly repayments - but without being charged interest on top. You’ll usually need a strong credit history and rating to be approved.

You’ll essentially take out an interest-free loan. Dealerships and showrooms typically offer 0% finance, but it may mean you have less bargaining power on the purchase price of the vehicle. An interest-free finance deal could be enticing but remember providers may look to make money elsewhere through other costs and fees, so the overall cost over the term is the same as it would be with interest added. Take time to weigh up your options and compare different finance deals taking into account the total costs – interest and any additional fees.  

Is car finance worth it?

Whether getting a car on finance is the right choice for you will depend on your personal, financial circumstances including your credit history. With a personal loan, PCP or HP deal, you’re borrowing money which needs to be paid back. You’ll need to be sure you can afford to meet your repayments.   

Buying a car through a PCP or HP deal is a popular option, mostly because it makes financing a new car more affordable. Car finance lets you pay off your new wheels over a number of years and as long as you work out what you can afford to pay each month, you’re likely to have a wider choice of cars to pick from than you would buying the car outright with cash.  

Unsure about whether to take out a loan for your car? Our car loan calculator can give you a good idea of how much your loan will cost you, factoring in the APR or interest rate, and the length of term, to work out how much it’ll cost you. 

What other ways are there to finance a car?

There are alternative ways to buy a car – you could finance your new car with a credit card, or you could save up and buy with cash. 

Buying a car with a credit card

Credit cards are another way to finance your new wheels. Using a credit card to buy a car works best as part of a cash purchase – if you buy a car entirely on credit, your repayments are likely to end up being very high. 

  • The most affordable credit card to use is a 0%-interest purchase credit card. These cards generally have decent interest-free periods

  • Once the interest-free period ends your card rate is likely to rise, so you’ll need to switch to another 0% card where possible. A 0% balance transfer card could be a good option, for example 

  • If you make part of your purchase on a credit card, there are legal protections which will help you if anything goes wrong, such as your car being faulty or the supplier goes bust before the vehicle arrives. You are protected up to a limit of £30,000 under the consumer credit act

  •  Be aware some dealerships don’t allow credit card purchases. This is because they get charged a fee for credit card transactions which they can’t pass on to customers. Find out in advance to avoid any nasty surprises once you’ve found your car  

Buying a car with cash

If you can afford to, it’s a good idea to consider buying a car with your own money. Borrowing money (whether with a loan, PCP, or HP) will cost you more in the long run through interest payments. If you don’t have all the money, it’s worth saving as much as you can for the same reason. The smaller the loan you take out, or the larger the deposit you can put down, the less you’ll pay overall. 

However, one thing to consider is the protection that comes from buying a car through finance. With finance, you’ll usually be able to take the car back to the dealer if it’s faulty, with free repairs and servicing sometimes part of the deal. Read the small print of your car finance deal to find out what protection or added features you might be entitled to.

Other useful guides  

 

Still unsure of the best finance route for your new car? We have a range of useful guides which explore the various options in more depth, including...

Compare car finance with MoneySuperMarket

Whichever finance deal you choose it couldn’t be easier to compare with MoneySuperMarket. We’ve teamed up with Motiv to bring you the best car finance deals on the market from over 30 leading lenders. We’ll help you compare quotes by size, duration, and interest rates, so you can find the perfect deal for your needs.   

Simply give us a few personal details and information about the car you’d like to buy – and all the hard work’s on us. Try it now and see how much you could save. 

Want to buy your new wheels with a car loan – search with us and find great deals from leading UK loan providers across the market. Searching won’t affect your credit score.