Car finance: know your options

You can’t beat the sense of freedom that comes with owning a car. But with so many finance options available to help you cover the cost of your vehicle, it’s easy to feel a bit lost when it comes to choosing the route that’s best for you.

With over 2.4 million cars bought on finance and the car finance market totalling over £37.4 billion last year, it’s clear that buying a vehicle outright isn’t always to go-to option for many of us.

To help steer you in the right direction, we asked 4,600 drivers for their opinions on car finance. Unsurprisingly, affordability was the main driver on our respondents’ mind, with 68% not bothered by the finance option they opted for, as long as they could afford the monthly payment.

But with so many options out there, should this be the only consideration that impacts your final decision?

Whether you’re looking to finance a car for the first time or fancying taking a road less travelled for your next vehicle purchase, it pays to get up to speed with the options available before signing on the dotted line and putting the pedal to the metal. Explore the ins and outs of car finance with our guide.

Understanding the car finance options

In a nutshell, car finance essentially means that instead of buying a car with cash you’ve saved, you borrow the money instead. You pay an agreed amount each month, some with interest, some with other fees. At the end of the agreement you can choose to either keep the car, trade it in, or in some cases hand it back and walk away altogether.

Sounds straightforward, right? But it’s the finer details that really matter. Here’s a quick guide to the main finance options:

  • Hire purchase. This requires a deposit (usually 10%) and you pay the balance off in fixed monthly instalments. You’ll still need to pay for maintenance, but you can do as many miles as you like. Once the balance is clear, you own the car.
  • Personal contract purchase (PCP). This also requires a deposit, but the resale value of the car is deferred until the end of the agreement meaning your fixed monthly instalments can be lower. Your mileage will be limited to an agreed level and you include maintenance in your monthly repayments. You return the car at the end of the agreement or pay the resale value and keep it.
  • Personal car loan. This involves borrowing money from a bank or building society to buy the car outright. There’s no initial deposit and you make monthly repayments with interest over one to seven years. No mileage limits are involved but you must cover all servicing costs yourself.
  • Personal contract hire (PCH). This is a lease agreement under which you never own the car outright. You pay a few months’ value up front (typically three months), followed by a monthly amount. Costs for servicing and car tax are included, so all you need to pay for is fuel. When the agreement ends, you return the car.

What is hire purchase and how does it work?

Hire purchase is one of the simplest car finance options. Basically, you hire the car for an agreed time, then pay the final instalment plus an ‘option to purchase’ fee, and the car’s yours. It’s available from dealerships and brokers, so it’s worth shopping around for the best deal. Plus, it works for both new and second-hand cars.

Pros of
hire purchase

  • Flexibility. Repayment periods can be anything from one to five years, with the longer terms allowing you to borrow more while staying within an affordable monthly payment.
  • Usually involves a relatively low deposit, around 10% of the overall price.
  • Fixed interest rates and monthly payments, which can help you budget.
  • No mileage restrictions.
  • You can change your mind – some deals offer the option to return the car once you’ve paid half the cost, with no further payments.

Cons of
hire purchase

  • The longer the repayment term, the more interest you pay.
  • The deposit amount and repayment period will affect monthly payments. A smaller deposit, for example, will probably mean a shorter loan term and a higher monthly repayment.
  • Monthly repayments might be cheaper on PCP or PCH deals.
  • You don’t own the car until the full amount is paid, so if you have trouble making payments it could be repossessed.
  • You can’t sell or modify the car before the contract ends without permission from the finance company.

Things to consider

From our survey, 38% of respondents liked that they could drive away with the car they wanted with an affordable monthly payment if they chose hire purchase. The option of a longer agreement term can make higher spec cars affordable for those on a fixed monthly budget, but it’s important to note the added costs this incurs over the period.

Additionally, 22% of our respondents who could afford the repayments on this option also agreed that it could be costly when adding on additional costs for servicing and maintenance.

It’s always worth checking out the product features and considerations to see how much these are likely to add onto your monthly payment.

What is personal contract purchase and how does it work?

Personal contract purchase (PCP) is broadly like HP, but with a few extra complexities. Like hire purchase, it’s used for both new and second-hand cars. It involves an initial deposit — usually around 10% of the car’s full value — and regular monthly repayments over an agreed term of typically three to five years.

At the outset you’ll agree the minimum resale value (to you) at the end of the term, when you’ll have three options:

Payment
option 1

Make a final payment (called a ‘balloon’ payment), which is usually a little less than the resale value of the car. Once this is paid, the car is yours.

Payment
option 2

Hand the car back with no further payments.

Payment
option 3

Use the balance between the car’s value and the ‘balloon’ payment as the deposit for a new deal.

Pros of
personal contract purchase

  • Usually lower monthly payments than hire purchase, so you might be able to afford a higher spec.
  • Guaranteed resale value.
  • Flexible options at the end of the term.

Cons of
personal contract purchase

  • The balloon payment can be several thousand pounds, depending on the agreed resale value of the car.
  • You’ll be subject to a mileage agreement, with financial penalties if you go over it.
  • You’ll need to keep the car in good condition to meet the terms of the guaranteed future value agreement.
  • If the car’s resale value is close to its actual value, there’ll be a smaller balance between it and the balloon payment, so you’ll have less of a deposit if you want to secure another deal.

Things to consider

From our survey, 45% of respondents who financed their car using PCP did so in order to purchase a higher value car at a reasonable monthly cost. But when buying outright at the end of the term this would mean the balloon payment required was high. In having to pay depreciation as well as the balloon payment, using PCP to purchase a higher value car can quickly stack up in terms of costs.

A total of 49% of respondents did value having the choice to purchase or walkaway at the end of the term though, so if you are looking at a lower value vehicle, PCP can certainly be an affordable option.

It’s worth paying close attention to additional limits and charges involved with PCP as well, with 28% of our respondents stating that they didn’t like the inflexibility of keeping within a mileage limit. The greater the limit you need to cover your use, the greater the monthly payment is. Pairing this with the penalties involved for exceeding the limit means it could be expensive if you cover long distances in your car.

What is a personal loan and how does it work?

A personal car loan does what is says on the tin: it’s a personal loan you use to buy a car. You can choose to borrow from a bank, building society or other institution, like a credit union, and repay the amount over several years. The loan doesn’t have to cover the entire cost of the car —you might only need to top up what you’ve already saved.

If you choose this route, you may need to pay a little more than you would with some of the other finance options, but you’ll own your car from the outset and could pay back less in capital and interest than you would through other car finance options.

Pros of
a personal car loan

  • Simplicity. It’s a straightforward arrangement, and can be made in person, over the phone or online.
  • You choose the repayment term that works best for you.
  • You own the car from the outset.
  • You’re in charge of the deal and can spend the money any way you want.
  • Option to cancel – personal loans have a built-in cooling off period, so if you change your mind within 14 days, you can cancel without penalty.

Cons of
a personal car loan

  • Interest can be fixed or variable, so take that into account. You might also be charged higher rates for loans of smaller value.
  • Your credit rating affects your eligibility and could also impact interest rates.
  • You’ll have to pay for servicing, maintenance and repairs separately.
  • Monthly payments can be lower, but may be higher than other forms of finance depending on the term of the loan.

Things to consider

Although they were able to have control over the deal and own the car from the outset, 21% of our respondents disliked having to cover all servicing and maintenance costs separately. It’s worth bearing in mind that you will be left to your own devices to cover all repairs as you own the car from the start.

There’s also a lot of choice when it comes to choosing a car loan so it could be worth taking independent advice or using comparison sites before applying to find the best deal.

What is personal contract hire and how does it work?

Personal contract hire is essentially a lease agreement. It involves the same level of financial commitment as other methods – an initial a deposit and an agreed monthly fee – but without any option to buy at the end. Personal contract hire agreements usually last two to four years and are more typically applied to new cars.

Pros of
personal contract hire

  • No interest – you’re not taking out a loan, so there’s no interest to pay.
  • It could be a way to drive a brand -new car, and switch to another every few years.
  • PCH deals can include servicing, MOTs and road tax.
  • Because PCH normally applies to new cars, you’re protected by a manufacturer’s warranty.
red cross

Cons of
personal contract hire

  • Your hire agreement will be subject to restrictions around mileage and conditions. You’ll have to stick to the agreed mileage and make sure any damage over and above normal wear and tear is fixed or pay a hefty financial penalty.
  • There’s usually a processing fee to set up your deal.
  • You have no option to buy the car, and you certainly can’t sell it!

Things to consider

A total of 57% of participants from our survey liked not having to worry about major servicing costs, as cars financed under personal contract hire are covered by a manufacturer’s warranty. Those who had smaller damages (anything above wear and tear) would have had to pay to get the car fixed before handing the car back or would have faced expensive fines. It’s worth double checking the definition of ‘normal’ wear and tear within your agreement and what would be classed as ‘damage’, as this could be a grey area that means you may end up out of pocket.

Pay attention to the extras in your lease package as well and ask about servicing, MOT and road tax costs to make sure the cost of servicing the car would be less than you’d pay outside the contract.

Deciding on the best car finance option

When it comes down to choosing a car finance option, it depends entirely on your financial circumstances, the cost and value of the car you want to buy, and the way you’re going to use it. However, we hope this article gave some helpful information you may not have considered before.

Here’s some things to bear in mind when you’re buying your next car:

  • 89% of our respondents were prepared to shop around for the best deal, so it’s always worth looking at more than one source and comparing deals.
  • Check independent comparison sites or ask for independent advice.
  • Don’t be pressured by salespeople into a deal you don’t want.
  • Remember to take the long-term view. The monthly repayments may be enticing, but if you’re paying them over a longer period, you’ll end up paying more.
  • Pay attention to penalties associated with your finance type, like mileage limits and damages.
  • When you’ve made your decision, get everything in writing, no handshake deals.
  • Pay attention to terms and conditions, so you know exactly what charges you could face if you don’t meet them.

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