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What is car finance?

What is car finance?

Car finance allows you to spread the cost of your new wheels - some options also give you the chance to drive a car you couldn’t afford to buy outright, or to change your car regularly. Read this guide to learn about the best types of car finance and choose the best one for you.

  • Car finance enables you to spread the cost of a new car
  • You may be able to afford a more expensive car than you could if you paid cash
  • Some car finance options enable you to regularly change or upgrade your car

What types of car finance are there?

Hire Purchase (HP)

HP might be for you if:

  • you want to spread the cost of buying a car over one to five years
  • you want to know what you’ll be paying each month
  • you can put down up to 10% of the purchase price as a deposit
  • you have a less than perfect credit record
  • you want to own the car at the end of the term
  • you don’t want a limit on how many miles you can drive

With HP you pay a monthly amount to use the car and will eventually own it at the end of the deal.You’ll need to pay an “option to purchase” fee at the end — this is normally about £200.

It is a secured loan with the car itself acting as security. This means it can be repossessed if you miss payments.

Because the car is owned by the HP company up until the final payment, lenders are often happier to lend to people with poor credit.

On the downside, higher interest rates can mean HP can work out expensive compared to PCP. If you fall behind on repayments, your car might be repossessed.

You can drive as far as you like while paying off your loan – unlike some other finance options, HP doesn’t come with any mileage restrictions.

Personal Contract Purchase (PCP)

PCP might be a good option if you:

  • want lower monthly payments than on HP
  • want your monthly payment to include service and maintenance
  • can afford to put down a 10% deposit for a car
  • are buying a new or new-ish car
  • want the option to pay a lump sum to own the car at the end of the term or to return it
  • want to regularly change the car you drive
  • don’t mind a mileage limit

A personal contract purchase (or plan) is a type of loan. But you only borrow the difference between the car’s current value and its expected value at the end of the agreement.

This might sound complicated but don’t worry – the finance company will work out this figure for you. It’s called the ‘guaranteed minimum future value’ or GMFV.

So, your loan amount will be the car’s value, minus the GMFV, and minus any deposit.

Because you’re not borrowing the whole value of the car, monthly payments are lower than on other finance plans.

At the end of the term you have three options:

  • Return the car
  • Pay a ‘balloon payment’ (equivalent to the GMFV) and keep the car
  • Use the car’s current value towards buying a new car

PCP is most commonly offered on new cars, with some deals including maintenance and servicing. This can make budgeting over the term (normally three to five years) easier.

PCP deals come with a mileage allowance – you’ll be charged an extra fee if you go over it.

Some PCP deals mean you will pay more in total then with other types of finance.

Personal Contract Hire (PCH)

PCH might be suitable if you:

  • want an arrangement similar to leasing a car
  • want your monthly payment to include delivery, breakdown, road tax and a warranty
  • are happy to pay for any damage to the car
  • are able to pay for a few months’ lease upfront
  • don’t want to ever own the car
  • don’t mind a mileage limit

Personal contract hire is similar to leasing a car. You’ll need to pay a deposit upfront and then monthly payments.

In general, the longer the agreement, the lower the monthly payments.

Payments normally include delivery, breakdown, road tax and a warranty – so it’s a great option if you need to budget.

The key difference between PCH and other finance options is that you never actually own the car with PCH. You give it back at the end of the term.

Just so you know – PCH can be hard, and expensive, to get out of. It tends to be used by businesses, rather than individuals. You’ll also have to pay for any damage that occurs during the term, so the car needs to be returned in good condition.

Loans

Personal car loan

Taking out a personal loan to buy a car might suitable if you:

  • want a finance deal separate to your car
  • are happy to budget for maintenance and services
  • want to buy a car without saving up or putting down a deposit
  • have a decent credit score which will give you access to more competitive rates
  • want to own the car straight away
  • Accept that your car will depreciate in value over time
  • want to be free to drive as many miles as you want

Car loan term lengths can vary from12 months up to five or seven years. You’ll make fixed monthly repayments to pay back the money you borrowed, plus interest. There may be extra charges if you want to pay the loan back early.

Interest rates vary depending on:

  • the term
  • how much you borrow
  • your credit rating
  • the lender

The APR on personal loans may be higher than secured options such as HP or PCP, as the loan is not secured on the car.

Guarantor loan

Taking out a guarantor loan to buy a car might be right for you if you:

  • don’t mind paying a higher interest rate
  • have someone who’s happy to be your guarantor and make repayments on your loan if you can’t
  • can budget for maintenance and services
  • don’t have a deposit saved up
  • have a poor credit rating
  • want to own the car straight away with a finance deal separate to your car
  • want to be free to drive as many miles as you want

If you have a poor credit rating, a guarantor loan could be your only option. A guarantor is someone who promises to step in and repay the loan if you can’t.

The added back-up gives lenders confidence they will get their money back.

But despite this extra assurance, rates on guarantor loans are higher than mainstream loans.

If you miss a payment, the lender will tell the guarantor and expect them to step in and make the payment. If they don’t, they could face legal action and it will also affect their credit score..

There’s a lot of trust involved in guarantor loans – both of you need to fully understand what you’re signing up for.


Overview of finance types:

| | HP | PCP | PCH | Personal loan | Guarantor loan | |---------------------------------------------------------|---------|---------|---------|---------------|----------------| | Deposit required? | Usually | Usually | Usually | no | no | | Fixed monthly repayments? | yes | yes | yes | yes | yes | | Optional balloon payment? | no | yes | no | no | no | | Is the loan secured against an asset? (eg. home or car) | yes | yes | yes | no | no | | Do I own the car during the agreement? | no | no | no | yes | yes | | | | | | | | | Mileage charge | no | yes | yes | no | no | | Am I liable for repairs? | yes | yes | yes | yes | yes | | Can I get a used car? | yes | yes | yes | yes | yes | | Is the car mine at the end? | yes | no | no | yes | yes |


Getting car finance

Should I buy a car on finance?

Most people buy a car on finance these days – it’s become much more popular than buying outright with cash.

Rather than having to save up for years, finance enables you to get a car straight away and pay for it in monthly instalments.

Finance can also offer greater flexibility. For example, with PCP you get low monthly payments and can choose to hand the car back when the contract ends, or make a final payment to buy it.

If you like to regularly change your car, you can hand the car back, then take out another plan for a different car.

Maintenance is often included in finance plans – this makes it easier to budget.

On the downside, buying a car on finance means you’ll be paying more than if you bought a car outright with cash because of the added interest.

You’ll also need to be sure you can afford it every month, as missed payments can result in late payment fees, and be potentially damaging to your credit score. Depending on the credit option, missed payments may result in your losing your car.

How to apply for car finance

Applying for car finance is similar to applications for other loans.

You’ll need to:

· Be aged over 18

· Pass affordability checks

· Undergo a credit check

· Prove your address for the past three years

· Provide proof of your identity (i.e. passport or driving license)

You can make an application via an online broker, or in person at a car dealership or showroom. Applications are normally approved within 24 hours.

How to find the best finance

Car finance can be a flexible way to borrow – there are different deals to suit all kinds of circumstances.

Some car finance deals don’t require a deposit, which can be handy if you don’t have enough cash saved up.

But, if you can get a deposit together, it means you can borrow less money and will probably be offered a better interest rate. This means you’ll pay less interest overall.

You should consider all the factors, including the APR, the total cost of borrowing and any other charges.

Choosing a longer finance term means cheaper monthly payments, but you’ll pay more overall.

It’s important to compare car finance deals before you agree to anything. Don’t rush into anything and don’t let sales staff pressure you. Always make sure you understand the terms and conditions of any agreement you enter into.

Can I get car finance on bad credit?

Yes, you can get car finance with bad credit.

But, you might be limited when it comes to the type of car finance you’ll be accepted for. And you will probably have to pay higher interest rates than the best deals on the market.

The best car finance deals are available to people with a good credit score. Some of the 0% APR or zero deposit deals you’ll see advertised may only be available to people with a good credit rating.

Saving up a decent deposit will increase your chances of being accepted for car finance despite a poor credit score.

Make sure the car finance option you choose is affordable as missed payments will worsen your credit score and make it even harder to be accepted for loans in the future.

How can I use car finance?

Can you buy used cars on finance?

Lenders will generally let you take out car finance for both not only new cars, but also used ones, depending on the age, condition and number of miles the vehicle has done.

But you won’t be able to get a PCP, HP or PCH deal on a car you’re buying from a private seller - for example, from a newspaper ad. If you need to borrow money to buy a car via private sale, you’ll need a credit card or loan.

Can I part exchange my current car?

You can normally part-exchange your current car if either:

  • You own it outright
  • You’re at the end of a HP deal
  • You’re at the end of a PCP finance agreement and the car is worth more than the optional final payment

How much your car will be worth to part-exchange will depend on the car's mileage, service history and specification, as well as industry data about the value of second-hand cars.

Part-exchanging your car can make your car finance deal cheaper. But it’s always worth seeing what your car might be worth if you sold it privately too.

Do I need guaranteed asset protection (gap) insurance?

Gap insurance covers the difference between the amount you paid for your car and the amount an insurance company would give you if it was written off or stolen.

While Gap insurance isn’t a legal requirement it can be a good idea if you buy a new car on finance.

This is because if you buy a brand new car, its value starts to fall straight away. Used cars will also depreciate (lose value) over time, but at a slower rate than brand new vehicles.

If the car is written off or stolen, your insurer will pay out what it's worth at the time. This is likely to be less than what you paid for it, especially if you bought it brand new.

Gap insurance can be handy if you’ve taken out a finance plan to buy your car as it can be used to pay off the loan.

You will always need your own car insurance, whatever type of car finance you take out.

Cost

How much will car finance cost me?

Car finance costs vary depending on:

  • If the car finance is secured or unsecured.
  • The term of the agreement. A longer term means lower monthly payments but the total cost will be higher.
  • The type of car finance: PCP contracts tend to be cheaper each month – but the balloon payment at the end to own the car can be large which could mean you end up paying more in total.
  • Whether or not maintenance and repairs are included in the agreement.
  • Your deposit: A bigger deposit means lower monthly payments, regardless of the type of car finance you take out.
  • Mileage: PCP and PCH deals both have an annual mileage allowance. A lower allowance means lower monthly payments. There will be an extra charge if you exceed your mileage.
  • The interest rate: You can compare interest rates on different finance deals by comparing representative APRs.
  • Fees and charges: Some car finance deals levy arrangement fees, early repayment charges or late payment fees.
  • Your credit history: The better your credit history the more competitive car finance deals you’ll have access to.

What is representative APR?

The representative Annual Percentage Rate (rep APR) is a simplified way of understanding the total cost of borrowing money.

When it comes to car finance, the rep APR combines the interest rate and any admin fees to give you one figure that can be easily compared across products.

The lower the rep APR, the lower the cost of borrowing – so it’s easy to understand.

What happens if I can't make my repayments?

If you fall behind on your car payments, talk to your finance company or lender as soon as you can. You might be able to return the car or get out of the agreement early - but doing so may mean you incur extra costs.

It is very important that you don’t miss any repayments. Missing a repayment will impact your credit score, stay on your credit file for six years and could harm your chances of getting credit in future.

With HP and PCP, you don’t own the car until the end of the agreement. If you fail to keep up repayments, the lender can take the car back.

If your finance deal is separate to your car – for example, a personal loan or credit card – you’ll be charged a penalty for late payments. But because the debt is not secured on the car, the lender can’t repossess it.

Buying your car with cash, a credit card or personal loan means you own it straight away, so if you got into financial difficulties you could sell it.

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