Car finance or bank loan - which is better?
Should you use car finance or a personal loan to fund your new car purchase? Read on and we’ll help you decide…
Key takeaways
When choosing between car finance and a bank loan, consider your eligibility, monthly budget, maintenance costs and mileage
Personal loans offer the lowest interest rates if you have a strong credit score
Whether you own the car or not depends on what type of car finance you choose
What are car finance and bank loans?
Car finance and bank loans both help you borrow money to buy a car but they work in slightly different ways:
How does car finance work?
Car finance is a catch-all term that is typically used to refer to a range of different financial products, including hire purchase (HP), personal contract purchase plans (PCP) and car leasing contracts. Here is a rundown of how each type of car finance works:
You pay a deposit (normally 10%) and then monthly repayments to the car finance company. Once you’ve made the final payment, you own the car.
You put down a deposit and borrow towards some of the remaining value of the car, then make fixed monthly payments until the contract ends. PCP deals usually last for 3 to 5 years and you have the option to own the car at the end of the contract by making one large ‘balloon’ payment.
You pay an upfront fee to lease the car and decide the contract length and annual mileage limit. Once you take out a contract, you pay fixed monthly payments until your contract ends. After the final payment, you return the car to the dealer or take out another lease.
Hire purchase (HP)
Personal contract purchase (PCP)
Car leasing
Our HP vs PCP guide will help you understand the differences between these two types of car finance.
How do car loans work?
Car loans are typically unsecured personal loans that you take out to pay for a car. With a car loan, you’ll own the car as soon as you’ve taken out the loan and will pay back the loan in monthly repayments.
What are the differences between car finance and a bank loan?
The main difference between car finance and a bank loan is that car finance deals are typically offered through a dealership at the time you’re buying your car. In contrast, you’ll take out a personal loan with a lender first, which you can then use to purchase any car.
This table compares a personal loan to car finance to give an idea of how different products work:
Personal loan | Car finance | |
|---|---|---|
Will I own the car from the start of the deal? | Yes | No |
Can I pay an up-front deposit? | Yes | Yes |
Are my monthly payments fixed? | Yes | Yes |
Can the car be taken away if I fall behind on repayments? | No | Yes |
Can I buy the car from a car dealership? | Yes | Yes |
Can I buy the car from a private seller? | Yes | No |
Can I make lower monthly payments? | No | Yes - PCP |
Can I own the car at the end of the deal? | Yes | Yes |
Is there an option to return the car at the end of the deal? | No | Yes - PCP |
Are there any annual mileage restrictions? | No | Yes - PCP |
Can I modify the car during the deal? | Yes | No |
Source: Motiv
Pros and cons of car finance
Here are some pros and cons to consider when looking at car finance:
Pros
No large upfront cost or deposit required
Access to a better choice of vehicles
Flexible contract agreements allowing you to spread the cost
Improve your credit score if you keep up with your payments
Option to keep the car with a PCP agreement
Cons
Higher interest rates than other types of loans
Longer term debt agreements compared with other options
There is a risk that the outstanding loan exceeds the value of the car
PCP agreements have mileage restrictions and are strict on wear and tear
You're delaying ownership and won't own the car until you've made all the payments
Pros and cons of car loans
Here are some pros and cons to consider when using a bank loan to buy a car:
Pros
You own the car from the beginning
Lower interest rates than other financing options if you have a good credit score
More choice of cars, as you can buy from private sellers and car dealerships
No restrictions such as age or mileage
You can modify the car, as it belongs to you
Cons
Not an accessible option for those with a poor or limited credit history
More time consuming, as you have to arrange the finances yourself
You can't hand the car back or end the contract earlier, you still have to pay off the loan
Doesn't offer the same level of cover as you'd get with car finance e.g. car warranty or service
The car might be worth less than you paid for the loan by the time you pay it off
Should I get car finance or a bank loan?
It can be difficult to decide whether to take out a personal loan or a car finance deal for your car. Choosing the right option will largely depend on your financial circumstances and personal preference.
For example, do you want the lowest possible monthly payment? Would you like to own the car outright from the start or prefer the flexibility to trade it in at a later date?
Here are some things to consider before taking out car finance or a bank loan:
A bank loan or hire purchase plan (HP) may offer the lowest overall costs, but a personal contract plan (PCP) will usually give lower monthly payments. While PCPs were previously typically only for higher value cars, there are an increasing number of PCP deals available for used cars, requiring lower monthly repayments and low or even no deposits.
A personal loan gives you the flexibility to buy a vehicle from wherever you choose. In contrast, with HP and PCP you’ll probably need to buy your car from a dealership. While you can get cheap deals buying privately many are ‘sold as seen’ whilst with a dealership, you’ll have recourse if later there are issues with the car.
While you’ll have the option to own the car at the end of the agreement with all of these finance options, you’ll need to make a substantial ‘balloon’ payment at the end of the deal if you choose a PCP agreement. Budget for this if you are going to keep the car or look for a loan at the appropriate time to cover this extra cost.
It’s always a good idea to properly maintain your car, but with HP and PCP deals there’s likely to be a standard required from the lender. In particular with PCP agreements, if you decide not to pay the balloon payment and return the car you may be charged if the car is damaged beyond fair wear and tear.
A personal loan or HP agreement will give you the freedom to drive as many miles as you want each year. In contrast with a PCP deal, you’ll have an annual maximum limit you can drive. If you go over this contractual limit there will be a charge, typically around five pence to 10 pence per mile but check with your lender.
You’re more likely to be offered an HP deal than a PCP deal if you have poor credit. But with HP the car will usually have to be worth at least £3,000 to be eligible. Below this value, a personal loan or credit card are likely to be your main options.
What's your monthly budget?
What car do you want?
Do you want to own the car?
Have you considered car maintenance?
Do you need extra mileage?
What’s the best route if you have poor credit?
Which option gives me the lowest monthly payments?
If your goal is to keep your monthly instalments to a minimum, it is worth considering a PCP plan. You’ll typically pay lower monthly payments because you’re just paying off the expected ‘depreciation’ in the value of the vehicle.
With a PCP plan, you’ll generally need to be buying a car worth £10,000 or more and will usually need at least a fair credit rating to be accepted. Visit our car finance calculator to see how much a deal could cost you.
At the end of the agreement, you'll have the option to pay a large ‘balloon’ payment if you want to keep the car. But drivers may decide to trade in and simply start a new PCP agreement on a new car, so they never actually own a vehicle outright.
Is a personal loan cheaper than car finance?
For many car buyers, the goal is to get the lowest rate or APR and pay the least interest over the term of the deal. But the rate you're offered will depend on your credit history and credit rating.
If you have a strong credit score, a personal loan is likely to offer the lowest rate and will be typically cheaper than car finance. But if you’ve struggled with bad credit in the past, car finance will probably offer you better rates compared to a loan.
If you have particularly bad credit history then car finance is likely to be your only option as many personal loans will be out of reach.
EXCELLENT CREDIT RATING | Personal loan | Hire purchase car finance |
|---|---|---|
Total borrowing (car price) | £15,000 | £15,000 |
Representative APR | 5.8% | 9.9% |
Monthly repayments | £349.88 | £376.68 |
Total payable: |
|
|
48 regular payments | £16,794 | £18,081 |
Total cost of credit | £1,794 | £3,091 |
FAIR CREDIT RATING | Personal loan | Hire purchase car finance |
|---|---|---|
Total borrowing (car price) | £15,000 | £15,000 |
Representative APR | 26.9% | 13.9% |
Monthly repayments | £489.53 | £403.05 |
Total payable: |
|
|
48 monthly payments | £23,498 | £19,347 |
Total cost of credit | £8,498 | £4,357 |
*Source: Motiv September 2023
The tables below illustrate this point. They show that for a driver with excellent credit a personal loan is typically the cheaper option compared to other types of car finance – hire purchase has been used in the example below.
But for someone with a ‘fair’ credit score, who could not get a low personal loan rate, then in many cases, car finance is likely to be cheaper. This is because of the relative interest rates or APRs.
Am I eligible for car finance or a bank loan?
The quickest way to check if you're eligible for car finance deals is to use our free car finance calculator or loan calculator tools. Here are some questions you may be asked to check if you meet the criteria:
Typically, lenders require you to be at least 18 years old and in some cases you may need to be over 21
Whether applying for car finance or a loan you will need sufficient income, once your existing expenditure has been taken into account, to be able to afford repayments
A good credit score helps show you are financially responsible and gives lenders and finance providers confidence you won’t default on your debt
The bigger the loan or finance deal, the more your finances will be stretched. Lenders might have different criteria for small and large loans
Only applicable to car finance, putting down a bigger lump sum deposit means you won’t have to borrow as much and should increase your chances of being approved for finance
By putting down collateral such as your house, you may be able to achieve better terms on a secured loan or be offered a larger total amount
Age
Affordability
Credit history
Loan amount
Downpayment
Security
How does car finance or a personal loan affect my credit score?
Both car finance and personal loans can affect your credit score in the following ways:
Car finance
When you apply for car finance, the lender will perform a hard credit check, which can temporarily lower your credit score. Too many hard credit checks can negatively impact your credit score.
However, if you pay your regular monthly instalment on time, it can improve your credit score. If you miss a payment or end your contract early, this can also have a negative impact on your credit score.
Personal loan
A personal loan application triggers a hard inquiry on your credit report, which can temporarily lower your score. Any new debt and shorter average age of your accounts can further lower your score.
That being said, paying your loan repayments off on time each month can steadily improve your credit score.
Personal finance expert
Is your car finance or loan agreement is legitimate?
When dealing with loans and car finance, make sure the finance provider is FCA approved to avoid scams and unethical practices. Look for transparent terms, interest rates, and any additional fees in the finance agreement.
Where can you get car finance or a personal loan?
You can get car finance or a personal loan from various sources in the UK, including:
Personal loan options
Comparison websites: Online comparison websites such as MoneySuperMarket allow you to compare loan options from different lenders, helping you find the best rates and terms for your financial situation
Banks and financial institutions: Traditional banks and lenders offer personal loans with fixed interest rates and terms. They assess your credit history and income to determine eligibility, with the best deals reserved for customers with a good credit score
Credit Unions: These member-based organisations offer personal loans and might have more flexible terms and lower interest rates
Car finance options
Car dealerships: Car dealers often provide financing options for purchasing new and used vehicles. Ensure the dealership is reputable and authorised by the Financial Conduct Authority (FCA).
Banks and online lenders: Similar to personal loans, you can also explore financing your car purchase through banks and online lenders.
What else do I need to consider?
There are a number of other things to consider when buying a car using a finance deal:
Depreciation of the car
If you’re looking to buy a brand new car then the manufacturer or dealership may have finance options with low or even a 0% interest rate. However, new cars typically lose value quickly in the first few years of ownership.
Whichever finance option you plump for make sure you understand the exact terms of the agreement by reading the small print and asking questions of the lender, so you aren’t caught out further down the line
Insurance
Remember whether you go for a finance deal or a car loan you’ll still have to get insurance for your car and pay the tax where applicable - and maintain the car. This will be your responsibility - not the lender’s, even when you don’t initially own the car, for example with a HP or PCP deal.
MoneySuperMarket can help you find car insurance which suits your needs from a wide range of insurers across the market.
Further borrowing
Taking out a car loan or car finance may have an impact on your ability to get other types of credit, such as a mortgage. Even if you keep on top of the monthly repayments, it will still reduce your overall affordability for more borrowing.
So be sure to factor it in, particularly if you are about to purchase a property or will soon be ready to remortgage your home
Other useful guides
Compare MoneySuperMarket car finance deals
You can compare car finance deals with our partner Motiv. It’s an online service that allows you to see if you’re eligible for HP and PCP deals and the rates you’ll pay.
It only takes a few minutes to enter your details and compare offers, it is free and searching for a deal won’t harm your credit score.
