How does car finance work?
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
Key takeaways
Car finance covers various options for borrowing money to buy a new or second-hand car
You will need to pay an initial non-refundable deposit and regular instalments throughout the contract
Choosing the best car finance option for your next car depends on your personal situation
If you’re looking to get on the road but can’t or don’t want to pay the full cost for a vehicle upfront, car finance could be right for you.
There are various options to choose from depending on your budget and personal preference.
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?
You borrow money from a lender, who pays the car dealership or current finance provider, and then paying the lender back in monthly instalments plus interest. Here is a breakdown with more information about how car finance works:
There are several types of car finance agreements, including personal contract purchase (PCP), hire purchase (HP), and personal loans
You'll need to submit an application form and provide details about yourself and the car you want to buy. The lender will check your credit history to determine if you can afford to pay back the loan
If approved, you'll sign a contract that outlines the terms of your loan, including the monthly payments, interest, and loan term. You'll also pay your initial deposit for the car at this point.
It is possible to get a car finance deal without paying a deposit. However, this will mean that you have more money to pay back in higher monthly payments and interest.
You'll make monthly payments until the end of your loan term, which is usually between one and five years
Depending on the type of finance agreement you chose, you'll either own the car when you finish paying it off or you'll have the option to return it
1. Choose a finance option
2. Apply for finance
3. Sign a contract and pay a deposit
4. Make payments
5. Own the car or give it back
What are the different types of car finance?
The main ways to finance a car include:
With a car loan you choose the loan amount you need 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. To get the lowest rate loan possible, make sure your credit score is as good as it can be before applying.
With personal contract purchase (PCP) 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.
Under a hire purchase (HP) agreement, you make monthly repayments which include the loan and interest. These contracts 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.
With personal contract hire (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 non-refundable deposit and 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.
Car loan
Personal contract purchase
Hire purchase
Personal contract hire
How much does car finance cost?
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 and how much you can afford to borrow based on your personal circumstances.
Which financing option is 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:
There are likely to be different finance options available if your car has been pre-owned
With better credit, you’ll be eligible for a wider range of finance deals and at lower interest rates
With a loan you’ll own your car from day one, but with hire purchase, for example, you won’t own the car until the end of the contract
Car loans and hire purchase arrangements often work best if you want to own the car
Some finance options set limits on your mileage, with penalties if you drive over the maximum limit
If you don't have a lot of free funds for an upfront deposit, you could consider a no deposit car finance deal
Prices may differ slightly depending on whether you want to drive a manual or automatic car
Are you looking for a new or used car?
How strong is your credit score?
Would you prefer to have higher monthly repayments but own your car outright?
Will you want to sell your car at the end of your deal?
How do you plan on using your car?
How much do you have for a deposit?
What type of car do you want to drive?
If you’re still unsure, our guide on the best ways to finance a car could help you with your decision.
Am I eligible for a car finance deal?
To be eligible for a car finance deal you’ll need to meet the finance provider’s criteria. This is likely to include being aged 18 or over and being a UK resident. Because you’re entering into a credit agreement you will also need to show you can afford to make regular payments.
This includes the finance provider running a credit check on you. The higher your credit score, the more likely you are to be accepted for a deal.
Can I get car finance with a bad credit score?
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
Take out an interest-free loan for the vehicle
Pay off the loan in instalments over the agreed period
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.
How long will my finance term last?
The length of your car finance contract will depend on what you agree with the finance provider. Car finance, such as HP or PCP, tends to run from around 2 to 5 years.
If you’re taking out a car loan it could be a similar term. It’s worth remembering that the longer you pay regular instalments the more in total interest you’re likely to end up paying too.
What happens at the end of the finance term?
The type of car finance you’ve taken out will dictate your options at the end of the contract, as follows:
Personal contract purchase: You have the choice to make a one large ‘balloon’ payment to purchase the car. Alternatively, you can return it and walk away or take out a new PCP contract.
Hire purchase: You will own the car after the final payment has been made.
Personal contract hire/leasing: You return the vehicle at the end of the term and can walk away or decide to take out a new lease.
Personal Finance & Insurance Expert
Our expert says...
Car finance is a big market with lots of options and it’s important to find the right one for you. You’ll need to work out all the costs for the entire contract, including fees and interest charged by the provider, and you’ll need to check what happens if your situation changes and you decide to give it back early.
What happens if I pay off my car finance 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. Your credit score may also be affected if you pay off your debt early.
What are the alternatives to financing a car?
You have a couple of alternatives to financing a car:
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 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.
Buying a car with a credit card
Buying a car with cash
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’s easy to compare with MoneySuperMarket.
We’ve teamed up with car finance broker 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 is 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.
