car finance: what is it & what are your options?

When buying a new car, many people will opt to spread the payment for the vehicle out over a period of time, rather than paying one lump sum. This is what is referred to as ‘car finance’ although as with any type of loan, there is an approval process and no guarantee that you will be accepted for the agreement. Not knowing what’s required in an application or whether you’ll be approved before you even apply can be a daunting prospect, so we’ve put together a brief rundown of how the approval process for car finance works.

Your first action to take is to research the car finance options that are available to you. There are several main types of car finance, which we will outline below (see table at the end for a quick comparison guide).

Hire Purchase (HP)

A Hire Purchase agreement is probably the simplest kind of car finance to understand and also one of the most common ways to finance a car. It involves paying an upfront deposit, followed by paying the remaining value of the car in fixed monthly amounts over an agreed number of years (usually up to five). At the end of the payment period, and once you have paid the final amount, you become the owner of that vehicle. In many ways, Hire Purchase agreements are similar to getting a mortgage on a house.

Hire Purchases are best suited to people who plan to keep their car for a long time, beyond the finance period and are able to pay a fairly large deposit up front.

Advantages of HP:

• Usually easy to obtain.
• Buyer can choose both deposit and term of repayment.
• The car is yours to keep at the end of the agreement.
• Finance period up to 5 years, which is longer than many other options.
• In total, you will usually pay less for your car than with a PCP, especially if you are planning to keep your car long term.

Disadvantages of HP:

• Monthly payments are usually higher than with a PCP, which means that the value of the car you can afford, is likely to be less.
• They are usually a fixed contract so if your financial circumstances change during the finance period and you are unable to upkeep payments; your credit score could suffer.
• You will usually end up paying a bit more for your car over the HP period than had you bought the asset outright.

Personal Contract Purchase (PCP)

A PCP is a bit more complicated than an HP, although they are gradually becoming more common because they can be more beneficial for the dealer in the long run. Unlike an HP, you are unlikely to pay off the full value of the car and unless you choose to, you will not automatically own the vehicle at the end of the finance period. Like an HP, you will pay a deposit followed by monthly sums over an agreed period of time, however, the amount you pay each month is usually less and the term is usually shorter than an HP. This is because instead of paying off the value of the car, you are paying the amount it has depreciated between the start of your agreement and the end of it. As a result, at the end of the finance agreement, there will still be a significant sum of the car value that has gone unpaid. At this point, you have several options; return the car to the dealer, pay the difference, which is known as a “balloon payment” and own the car, or you can part exchange the car for a new one on another PCP agreement.

A PCP agreement would work best for somebody who wishes to regularly change their vehicle every few years.

Advantages of PCP:

• Typically much lower monthly repayments than HP
• More flexibility with several options available to you at the end of the contract.
• You could be able to buy a car that is worth more than you could otherwise afford with low monthly payments.
• Usually, PCP’s are only offered on new or nearly new cars.
• Your car is guaranteed to be worth a minimum amount at the end of the deal.
• You could get a new car every few years.

Disadvantages of PCP:

• You won’t automatically own the car during or at the end of the finance period and will have to pay an additional sum (and sometimes an admin fee on top) if you wish to.
• Most PCP’s will include mileage restrictions; should you exceed the limit you will usually have to pay a charge for every mile you go over.
• You can also be charged if the car is returned in an unsatisfactory condition and may be subject to additional charges for regular servicing.

Personal Contract Hire (PCH)

PCH agreements essentially allow you to rent a car for private use over a fixed period of time, at the end of which you return the car without purchasing it. Some lenders might allow you to extend the rental period however unlike HP and PCP, you will not be able to own the car at any point. This makes it an ideal option for people who have no intention to purchase a car. At the end of the contract, you have no financial obligation to the lender and you will be free to hire, lease or purchase any other vehicle.

Advantages of PCH:

• Simple to arrange.
• You won’t have to think about the car’s depreciation or value at resale.
• Lower monthly payments than if you were buying it.
• Car maintenance and servicing extras can be added to the monthly payments.
• Various mileage terms and finance periods to suit your personal requirements.

Disadvantages of PCH:

• There are no options for buying the car at the end of the finance period.
• If you exceed the agreed mileage amount, you will usually have to pay an additional charge.
• If you wish to terminate the contract at any point you could be subject to an expensive fee.
• Like with PCP, your car will be assessed for wear and tear and any perceived damage would have to be paid for by you.
• You must have full comprehensive cover for the vehicle before you can drive it.

Personal Loan (PL)

 The final way in which people finance their cars is through personal loans from a bank or building society. You can either take out a loan to pay the full cost of the vehicle or a sum that will partially cover the cost if you are planning to cash buy and don’t have the full amount ready.

Advantages of PL:

• No deposit required.
• You own the car whilst you are paying off your loan so, in theory, you can sell it (but check with your lender first).
• You won’t be required to return the car back after you have paid off your loan and you will not have any mileage restrictions.
• If you have a good credit rating, the fixed interest rate is likely to be quite low.
• Full flexibility over loan period, however the longer you choose, the more interest you will have to pay.

Disadvantages of PL:

• If you have a poor credit history, it is difficult to get approved or get the best interest rates.
• You need to be able to commit to paying back the loan before you take it out. Your credit rating will be damaged if you are unable to repay your loan, and as it is unsecured any of your assets could be seized in the event of missing payments. This will prevent you from easily obtaining further loans in the future, such as a mortgage.
• Because you are paying for the full value of the car, monthly repayments are likely to be higher than with say, a PCP agreement.
• Be wary of dealers offering low or 0% interest rates, the APR is the figure you need to be paying attention to as this includes all additional charges, including interest.

To help you decide whether to apply and which form of car finance is best for you, you will need to take into consideration, your:

Credit Score

This is what lenders will be analysing when they are reviewing your application to see whether you are a reliable and low-risk person to lend money to. It is worth looking through it before you submit your application in order to ensure that your file is up to date and all information is correct. If you know that your credit score will reflect badly on you, car finance may not be an option so this should be one of the first things you check.

Budget for a deposit

The more money you have to put towards a deposit the better, as this means that the amount you’ll need to be loaned will be less. It may take a bit more time but saving up for a slightly larger deposit could increase your chances of becoming approved for a finance agreement.

Ability to Afford Repayments

Ensure that you will have enough money set aside each month to repay your car finance loan. This will require you to look at your current income and outgoings in order to calculate how much you can realistically afford to repay each month. You should think about how long a period of time you are prepared to pay off your loan over too; the longer the period the lower the monthly payments but you will end up paying more in interest. This could result in you paying more than the actual value of the vehicle.

Different Options

Make sure you know all of your options before you apply. Take time to shop around and research the kind of vehicle you will need and the finance options available to you. You’ll also need to decide whether to go through a dealer directly, car broker, lender or car supermarket to get your finance agreement approved (this will depend on the type of finance you want as not all providers offer all of the options above).

It’s also essential to become familiar with APR (annual percentage rate), which is the interest rate you will be paying over the course of your finance agreement. Look at how it compares on the different finance plans available as well as the rate on a personal loan if you are considering going for one of the first 3 options.