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Car finance explained

How does car finance work and what are my options?

Whether it’s HP, PCP or leasing, our guide to car finance explains the different options available when it comes to getting a new or second-hand car

By Tim Heming

Published: 08 February 2022

Man driving

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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. 

How does car finance work?

Whatever car finance option you choose, it will involve borrowing money from a lender to cover the cost of a new car. There are different types of car finance in the UK 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. This is if you’ve got a good credit score and can get a low rate loan deal. Choose the loan amount you need to borrow and how long you want to borrow it for. Once approved, the money will be paid directly to your account so you can buy the car - from a private seller or dealership. You then pay off the loan in instalments. 

Personal contract purchase

You pay a small deposit and take out a loan at the start to cover the depreciation of the car (how much the lender thinks the car will fall in value over the term of the contract). You then make monthly repayments with interest over the agreed term before deciding whether to 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 (the balloon payment) to keep the car. 

Hire purchase

Under a hire purchase agreement, you make monthly repayments to hire the car – this includes the loan and interest. They often require a deposit of around 10%, but typically the larger your deposit the better your finance terms will be. You choose the length of repayment period you prefer, usually up to five years and once you’ve made the final payment, the car is yours. 

Personal contract hire

With PCH or car leasing, you hire a new car for several years before returning it at the end of the lease period. Like other finance agreements, you usually pay a deposit and make monthly repayments. You’ll also be able to add servicing plans to your deal to ensure you hand the car back in good condition and avoid paying fines.  

Which car finance option is the best for me?

The best finance option for you will depend on your personal preference and financial situation, but there are a few things you should consider:  

  • Are you looking for a new or used car? There are likely to be different finance options available if your car has been pre-owned

  • How strong is your credit score? With better credit, you’ll be eligible for a wider range of finance deals and at lower interest rates 

  • Would you prefer to have higher monthly repayments but own your car outright? With a loan you’ll own your car from day one, but with a PCP deal or with leasing you won’t own the car for the duration of the plan, for example

  • Will you want to sell your car at the end of your deal? Car loans and hire purchase arrangements often work best if you want to own the car  

  • How do you plan on using your car? Some finance options set limits on your mileage, with penalties if you drive over the maximum limit allowed

If you’re still unsure, our guide on the best ways to finance a car could help you with your decision. 

How much will car finance cost me?

The cost of car finance is made up of your deposit, regular instalments, plus any final payment if you choose to own the vehicle at the end of the contract. There could also be additional charges if you need to pay for servicing and repairs or exceed the agreed mileage.  

Our Car Finance Calculator can help you calculate your monthly repayments depending on how much you want to borrow, or how much you can afford to borrow based on what you can pay monthly.

Can I get car finance with bad credit? 

Car finance companies will look at your credit history and credit score when deciding whether or not to lend to you. If you’ve had debt problems in the past and you’ve got a low credit score, you might not have access to the best deals, and you’ll usually be charged higher rates of interest.

That said, bad credit doesn’t have to mean you’ll be refused 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 finance or car loan.

How does 0% car finance work?

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

  1. Take out an interest-free loan for the vehicle

  2. Pay off the loan in instalments over the agreed period 

  3. Make the final instalment and own the car outright

Be wary of any catches with 0% finance. An interest-free finance deal could be enticing but dealerships may look to make back the money elsewhere through other charges and fees, such as a higher purchase price of the vehicle. 

Do I keep the car after the finance term ends?

Whether you keep the car depends on the type of car finance you have taken out. If you’ve opted for hire purchase, you’ll own the car once you have made your final payment. If you go for personal contract purchase, you have the option to make one large payment, known as a balloon payment, at the end of the agreed term to purchase the car – or you can return it. If you lease the car with personal contract hire, you return the vehicle at the end of the term. 

Should I try to pay off the deal early?

Whether paying off the deal early is a good idea depends on your personal situation, the type of car finance you have taken out and the conditions of the contract. In many cases, paying off a deal early can save you money through paying less interest overall. However, there may also be penalty charges to factor in, so check the terms and conditions. 

Is financing a car a good idea?

Car financing in the UK can be a good idea if it suits your needs and finances. For example, car finance might be the only way you can afford the new car that you want if you don’t have all the money upfront. 

With many different forms of car finance, dealerships can also be flexible over the deposit, servicing, mileage and term of the deal.

Alternatives to financing a car 

Buying a car with a credit card

If you’re looking to use a credit card, a 0% interest purchase credit card is often the best option because 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 have paid off what you have borrowed or consider switching to a 0% balance transfer card

Credit cards offer legal protection if anything goes wrong with your purchase, such as your car being faulty. But be aware some dealerships don’t allow credit card purchases because they get charged a fee for credit card transactions which they can’t pass on to customers. 

Buying a car with cash

Buying a car with your own money will work out cheaper than car finance because you don’t have to make 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, it’s worth considering the protection that comes from buying a car through finance where 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. 

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…

Car finance vs bank loan   

What is hire purchase?

Hire purchase vs leasing 

Used car finance 

Electric car finance 

 

Compare car finance with MoneySuperMarket

Whichever finance deal you choose it’s easy 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.