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Car loans

Car finance in the UK is actually pretty complicated. There are lots of different options out there, it’s not always clear how each one works at first glance, and it can be very hard to compare different products.

That’s why we’ve written this guide: we’ll clearly explain the different options available to you, making it easy to compare and work out what works best for your circumstances.

Once you’ve read our article on financing a car, you might want to take a look at some of the options available. Our loan calculator is a great place to start.

What are my options for paying for a car?

In this section, we’ll break down the most common ways to pay for a new car, with pros and cons of each.

Cash or savings

If you’re lucky enough to have enough money saved up to buy a car, you’re in a very strong position. By paying in cash, you avoid the costs that you’ll generally incur with finance, such as interest payments or fees.

But that’s not the only benefit: if you fall on hard times, because you own the car outright, you can simply sell it. That means you won’t be forced to keep making payments. You might also have more bargaining power – you can expect to be able to negotiate a discount with a dealer if paying with cash.

There is one thing to keep in mind though: you shouldn’t wipe out your savings with a car purchase. It’s always wise to keep a buffer in case you need it for emergencies, so be mindful of this if you’re using a significant portion of your savings to fund the purchase of a car.

Personal contract purchase (PCP)

PCP purchases have become popular in recent years. Here’s how they work:

1. You pay an upfront deposit on a vehicle, which you can then drive away.

2. You make an agreed number of fixed monthly repayments (these usually last 2-4 years) to the finance company.

3. At the end of the agreement, you can either:

    a. Give the car back and pay nothing further.
    b. Pay a final lump sum to buy the car outright.
    c. Part exchange that car for the new one, using equity you’ve built up.

If you think that sounds complicated, you’re not wrong: it’s certainly not a simple way of funding a car, and because it’s hard to compare it with other ways of paying for a car, you risk being blinded by the numbers. However, it’s popular because of the relatively low monthly payment (although the final payment is high if you do want to own the car), and the flexibility at the end of the agreement.

The final payment (in option b) is known as the Guaranteed Minimum Future Value. Calculated by the finance provider, it’s the estimated value of the car at the end of your contract, and assumes that you return it in good condition. Importantly, it’s based on a mileage limit which you agree with the dealer at the start of the contract. Once you’ve set this figure, it can’t be changed, and you’ll face significant additional charges if you go over the agreed mileage.

The main benefit – other than the fact that you’re spreading payments – is that PCP can be a good way to ensure that you’re able to change your car often. As well as the fact that it’s nice to have a new car, you’ll also probably save on repair and maintenance costs too.

Hire purchase (HP)

With a hire purchase plan, you pay a deposit and then spread the rest of the cost of the car over a longer period – typically between two and five years. Unlike a PCP agreement, at the end of a hire purchase plan you own the car outright – as a result, the deposit and monthly cost may be higher, but there’s no “final payment” to be made at the end of the contract.

The actual amount you have to deposit can vary: in general, a larger deposit means that the total cost will be reduced, as you only pay interest on the amount outstanding.

Hire purchase agreements also have the benefit that because you don’t own the car outright until the final payment is made, the finance provider is legally responsible for any faults with the car, and if the car dealer won’t put something right, they’ll have to step in.

HP and PCP deals are available from car dealerships and also from third-party providers, so you should have plenty of choice if you want to shop around.

Personal loan

The two types of finance described above (PCP and HP) are generally arranged via the seller. There’s a third financing option, which is a personal loan – Koyo is a personal loan provider – and you can use this type of financing option to purchase a car from a dealership or independent seller.

Why would you do this? A few reasons:

  • Transparency: a personal loan is clear and easy to understand.
  • Ownership: once you pay for a car with a personal loan, you own it. That means it’s yours to do with as you please – no mileage restrictions.
  • Bargaining power: once you’ve secured a loan, you’re not tied to a particular dealership’s financing options. That gives you the upper hand in negotiations.

The main drawback to mention is an important one: while ownership has its perks, unfortunately, it means that you’re liable for maintenance costs.

Overall though, it can be a great option, and if your personal circumstances change then many lenders allow early repayment at no extra cost. That means that should you need to, you can sell the car you purchase and use it to repay the loan (so long as you’re able to sell the car for a high enough price to cover the outstanding amount).

When is buying a car on finance a good idea?

As we’ve explained earlier, buying a car using a HP or PCP credit agreement has a few advantages when compared to cash or a simple loan:

    1. You spread the cost of car ownership over a few years – ideal if you don’t have enough cash savings to cover the purchase right away.
    2. In the case of PCP, you’ll know exactly how much the car will be worth at the end of the finance agreement, so you don’t need to worry about depreciation.
    3. You’ll also benefit from some additional consumer protections in case something goes wrong.

However, it’s always worth comparing a few different options, and you should be wary of any company that makes it difficult to do so.

It’s also worth taking extra care when a dealer or finance provider offers “0% finance”. As Money Saving Expert explains(1):

“Take these deals with a pinch of salt though, as they are likely to try to recoup their losses somewhere else by, for example, inflating the balloon payment or making the ticket price more expensive than if you would have bought the car outright.”

What are the advantages of buying a car with a loan?

Buying a car can be a good reason for a personal loan, and brings a number of potential advantages:

    1. You can arrange finance beforehand, and then negotiate with the dealer – you’ll be treated like a “cash buyer”, with extra leverage.
    2. It spreads the cost over a longer period – useful if you don’t have enough savings to comfortably purchase a car outright.
    3. If your circumstances change, you can sell the car, and use that to pay off your loan (although it’s worth noting that depending on how quickly your car depreciates, it might not cover the full amount).
    4. You’re not tied to a particular dealer – meaning you’re able to shop around for the best deal and lowest interest rates.
    5. Unlike with a PCP agreement, you’re not restricted to a particular annual mileage.

Related article: How to get a car loan with a bad credit

How can I work out the best option for me?

With so many options out there, it can be tough to work out which one suits you best.

You’ll want to consider 2 things:

    1. Which option best suits my circumstances?
    2. Which option has the lowest total cost?

The first question is hopefully not too hard to answer – before considering a loan or finance agreement, you should have a good idea of your finances, and should think about what might be likely to change in the future.

Type of finance Good for Pros Cons
Cash/savings People who have enough savings to comfortably cover the purchase Cheapest way to fund a car – no interest payments or fees; leverage when buying All money is paid upfront; not everyone has enough savings
HP People who want to spread the cost of car ownership Straightforward, easy to understand, fixed payments Higher monthly payments than PCP; you don’t own the car until you have made the final payment, inflexible
PCP People who want to move from new car to new car Option to switch to a new car at the end of agreement, or buy your existing one for a final payment Can be expensive; you don’t own the car until you have made the final payment, inflexible
Personal loan People who want flexibility No ties to any particular dealer; leverage when buying; simple to understand; flexible The finance provider won’t be responsible for correcting defects (unlike with HP and PCP agreements)

Related post: What credit score do you need to get car finance in the UK?

The second question is tougher: how can you work out what option is the best value? Without going into too much detail, the best way to do this is to work out the total cost of each option (the deposit, monthly payments, final payments and any fees) on the car you’re considering, and add those figures together. You’ll end up with a figure which is broadly (though not exactly) comparable.

Here’s a simplified example of how four different ways of paying for a £7,500 car stack up, assuming you’re looking at rates of around 19-20% APR:
a simplified example of how four different ways of paying for a £7,500 car stack up, assuming you’re looking at rates of around 19-20% APR:

APRs can vary greatly – Koyo’s representative APR is 27%.

*These numbers aren’t based on real-world data but are designed to show how different options might compare: by adding the total amount payable for each option, you can work out which will be the cheapest for you.

If you want to look into this in more detail, What Car Magazine has a thorough comparison with some real-world examples which might be worth a read.

What if I have a bad credit rating?

If you have a bad credit rating, it’s likely that you’ll have access to a smaller range of deals than borrowers with a good credit rating. However, all is not lost: you might still find there are plenty of options out there (you can take a look at our list of the best personal loans for people with a “fair” credit score), and it’s only by doing some investigation and comparison that you’ll be able to find the best option for you. If you want to read more about this, you can look at our guide to reasons for personal loan rejection.

It’s also worth considering Open Banking lenders, who are able to securely and safely view your bank account transactions (with your permission), meaning they can base decisions on affordability rather than just your credit history. Koyo is an example of an Open Banking lender, offering loans with a representative APR of 27%.

Is it better to finance a car through a bank or dealership?

Nowadays, banks and independent finance companies can offer tailored finance products to fund a car purchase – dealers aren’t the only ones who can offer a great HP deal, for example.

Dealers like it when you use their finance products because they earn a commission. That might mean they’ll give you a slightly better deal on a car. However, you should always shop around, and remember that you’re never obliged to use dealer financing packages. If you can find a better package elsewhere, you could save money.

Summary

Like so many things in life, the best option will be different for everyone. Hopefully, this guide has made the choices available a little clearer though, and if you’re looking for car finance then you’re probably in luck – there are so many options out there that there’s probably something for everyone.

If there’s anything you want to know that we haven’t covered, just let us know in the comments section below. And if you’re ready to take a look at some of the options available to you, our loan calculator is a great place to start!

Source: (1) https://www.moneysavingexpert.com/car-finance/personal-contract-purchase/