Understand whether car finance or a loan is right for you
Should you use car finance or a personal loan to fund your new car purchase? Read on and we’ll help you decide…
Working out the best way to fund a new car purchase can be confusing if you don’t have savings or the ready cash. Our handy guide can help you think through the different options - considering your financial situation, the type of car you’re looking to buy and your goals.
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. You will pay back the loan in monthly repayments.
How does car finance work?
There are different types of car finance available. Here’s a rundown of how they each work:
What you pay: A deposit (normally 10%) and then monthly repayments to the car finance company
Do you get to own the car? You own the car once you’ve made the final payment
What you pay: You put down a deposit and borrow towards some of the remaining value of the car. You then make fixed monthly payments until the contract ends. PCP deals usually last for 3 to 5 years
Do you get to own the car? You have the option to own the car at the end of the contract. You can make one large ‘balloon’ payment to keep the car
What you pay: You pay an upfront fee to lease the car. You then decide on contract length and agree to an annual mileage limit. Once you've finalised your contract, you make fixed monthly payments until the contract term ends
Do you get to own the car? No, after the final payment, you return the car to the dealership or take out another lease
What is the difference between car finance and a bank loan?
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 leasing contracts.
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 – 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:
Will I own the car from the start of the deal?
Can I pay an up-front deposit?
Are my monthly payments fixed?
Can the car be taken away if I fall behind on repayments?
Can I buy the car from a car dealership?
Can I buy the car from a private seller?
Can I make lower monthly payments?
Yes - PCP*
Can I own the car at the end of the deal?
Is there an option to return the car at the end of the deal?
Are there any annual mileage restrictions?
Yes - PCP*
Can I modify the car during the deal?
*There are two main types of car finance – hire purchase (HP) and personal contract purchase (PCP). A PCP deal is typically only an option on higher priced cars (worth more than £10,000) but PCP plans offer lower monthly payments and more options at the end of the deal - buy the car, trade it in and start a new PCP deal or hand back the car.
PCP does come with some additional considerations – for example annual mileage restrictions. Our HP vs PCP guide will help you understand the differences between these two types of car finance.
Am I eligible for car finance or a bank loan?
Eligibility for car finance or a bank loan depends on several factors, including:
Age: Typically, lenders require you to be at least 18 years old and in some cases you may need to be over 21
Affordability: 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
Credit history. A good credit score helps show you are financially responsible and gives lenders and finance providers confidence you won’t default on your debt
Loan amount. The bigger the loan or finance deal, the more your finances will be stretched. Lenders might have different criteria for small and large loans
Downpayment. 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
Security. 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
What do I need to consider before choosing the right option?
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 instance, 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 factors to consider when weighing up your options:
Consider your monthly budget - A bank loan or hire purchase plan may offer the lowest overall costs, but a personal contract plan 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
Choosing your car - 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
Do you want to own the car at the end of the finance term? 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
Maintenance of the car - 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
Restricted mileage with some finance options - 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
What’s the best route if I have poor credit? 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.
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 during the term of the agreement because you aren’t paying towards the full cost or value of the car. With a PCP set-up, you’re just paying off the expected ‘depreciation’ in the value of the vehicle.
At the end of the agreement, you’ll then 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.
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.
Is a personal loan cheaper than car finance?
For many car buyers, the goal is to get the lowest interest rate or APR and pay the least interest over the term of the deal. But the interest rate you are 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 interest rate. 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.
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.
EXCELLENT CREDIT RATING
Hire purchase car finance
Total borrowing (car price)
48 regular payments
Total cost of credit
FAIR CREDIT RATING
Hire purchase car finance
Total borrowing (car price)
48 monthly payments
Total cost of credit
*Source: Motiv September 2023
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.
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.
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.