Types of car finance: which option is best for you?

Car finance is designed to be helpful – it’s a useful way to spread the cost of a car over a few years. The trouble is, there are so many options, it can be hard to know where to start.

In this article, we’ll explain – simply and clearly – how the most popular types of car finance work, from car loans to PCP, and how to work out which option will be best for you.

We’ll also look at some less common options, and answer some FAQs at the end of the article.

If you already understand the options available to you and want to go with a personal loan, you can take a look at our loan calculator or make an application at www.koyoloans.com. Representative APR 27% on loans for £1,500-£12,000.

If not, read on!

11 types of car finance to consider

In this section, we’ll outline all of the mainstream forms of car finance available in the UK. We’ll also include a table at the end, with pros and cons for each one.

When running through these options, remember that your eligibility for most of the forms of finance mentioned below will be affected by your credit rating, and in some cases by the size of the deposit that you’re able to put down. For more information on what to do if you have a low credit score, take a look at our more detailed guides:

• How to get a car loan with a bad credit score and

• What credit score do you need to finance a car?

Cash

Before we get into different types of credit, it’s worth considering cash for your next car. Of course, not everyone is lucky enough to have enough savings to pay for a car up front, but if you do, it’s usually the cheapest way to buy a car, since you won’t have any monthly payments or interest to worry about.

However, research from What Car (1) did find that it’s sometimes cheaper to buy a new car on finance (in around 14% of cases), so it’s worth exploring all of your options.

If you do buy a car with cash, be careful not to wipe out all of your savings – it’s important to keep a buffer for emergencies.

Personal loan

One of the simplest ways to buy a car using finance is via an unsecured personal loan. A personal loan is very straightforward – you borrow an agreed amount and use that money to purchase a car. You make regular monthly payments until you’ve repaid the original total amount, plus interest. Your payments are agreed in advance, so you know exactly what you have to repay, and when.

As well as being simple and straightforward, with a personal loan you own your car right from the start. That means you can modify it, drive as much as you want, and even sell it.

The drawbacks are that it can be more expensive than other forms of finance (which we’ll cover later) and that you don’t have the benefit of locking in a fixed price when you come to sell it (which is a feature of PCP agreements).

Personal Contract Purchase (PCP)

With a PCP car finance agreement, you make an initial deposit, then monthly payments over an agreed number of years, and at the end of the contract, you have a choice:

• Hand back the keys and walk away,

• Make a final balloon payment (which is decided at the start of the agreement) and keep the car, or,

• Take out a new PCP deal

PCP can work out to be a cost-effective option, and it’s helpful to know you’ll be able to give your car back and receive a fixed amount of money at the end of the term. That means you don’t have to worry about unexpected depreciation.

However, you’ll need to pay a deposit (around 20% of the cost of the car), and – most importantly – you don’t own the car until you make the final payment. That means you’ll face mileage restrictions over the term of the agreement, and if there’s any damage to the car (or if you want to end the agreement early), you’ll face hefty additional charges.

Related post: PCP Versus Bank Loan: What’s The Best Way To Finance A Car?

Hire purchase (HP)

Hire purchase agreements are slightly simpler than PCP. You pay an initial deposit and make payments in monthly instalments, but unlike with PCP, there’s no balloon payment (a lump sum) at the end. As a result, monthly payments are higher (even if the total cost should be around the same), and there’s no option to hand back your car and walk away.

As with PCP, you don’t own the car until the final payment has been made, meaning the car effectively acts as security on the loan. However, HP agreements tend not to come with annual mileage restrictions.

Different dealers will have different car finance deals available, so it makes sense to shop around and explore your options.

Credit card

For some car purchases, it might be possible to use a credit card. In fact, if you’re able to use a card with a long 0% interest period, you might also be able to do it fairly cheaply.

There are a couple of drawbacks though: firstly, not every seller will accept a credit card as payment, and many will charge a fee for doing so (because they have to pay a fee to the card issuer).

More importantly, limits on a credit card tend to be relatively low (compared to other forms of finance) and some card companies have a limit on a single purchase of a few thousand pounds.

However, the advantages are that you can pay the money back at your own pace (although the longer you take, the more you’ll repay in interest) and you own the car from the outset, meaning that you can use it as much as you like and even sell it without penalty.

Part exchange

Although it’s not strictly car finance, many dealers (including online car supermarkets) will allow you to part exchange your existing car for a new one, reducing your purchase price by the value of your existing car.

The drawback? Not everyone accepts part exchange, and you’ll also have to negotiate with your dealership – it adds a layer of complexity to the transaction.

Personal Contract Hire (PCH)

PCH doesn’t actually involve car financing – instead, it’s a long term rental agreement, where you never own the car.

You pay a fixed monthly amount (often the first payment is higher) to borrow a car for an agreed amount of time, and at the end of the term, you simply hand it back. It can be a good option for people who always want to drive a new car, but you’ll need to keep the car in good condition and stick to an agreed mileage limit. At the end of the contract, you simply hand the car back.

Adding to your mortgage

It’s possible to borrow more on your mortgage and put this money towards a car purchase.

This can be a practical way to unlock large amounts of money (in the tens of thousands or more) and is often used to fund things like home improvements. However, mortgage debt is secured against your home, which means that your home is at risk if you fail to make repayments in full. As a result, it’s something to consider carefully: as a rule, you should avoid taking on any secured debt unless you have to.

Remortgaging in general involves a lot of fees and paperwork, so it’s also a complex way to fund a car purchase unless you’re due to remortgage anyway. And because mortgages are typically repaid over decades, even a low rate can add up over the full term.

Alternative options: guarantor, P2P and Open Banking loans

There are lots of different types of personal loans, and in this section, we’ll briefly cover a few of the most interesting ones.

Guarantor loans are personal loans where a guarantor (usually a family member) agrees to step in if the borrower isn’t able to repay in full. This can be helpful if you don’t have a good credit score, but there are lots of other ways to do this without needing a guarantor. If you’re interested, we’ve written about guarantor loans (and alternatives) in a previous article.

Peer to peer (P2P) loans work just like standard personal loans, except that your loan is funded directly by hundreds or thousands of ordinary people, who have lent money out via a platform. From the point of view of the borrower though, there’s no change – well-known P2P lending companies include RateSetter and Zopa.

Open Banking lenders like Koyo use secure technology to safely view your bank account data (such as your income and outgoings). By doing so, they’re able to verify that a given loan is affordable for you and make lending decisions based on your real financial information – rather than just based on what a credit reference agency says about you. Read more about lenders who use Open Banking.

This option can be particularly useful if you haven’t yet had a chance to build up a strong credit history.

The bottom line: which type of car finance is right for you?

That’s a lot to take in, so to help to simplify, we’ve put together the table below. It’s not exhaustive, but should help you to quickly compare the key features of each form of car finance.

Type of finance	Typical agreement length	Initial deposit?	Who owns the car?	Mileage restrictions?	Pros	Cons
Cash/savings	n/a	n/a	n/a	n/a	Usually the cheapest option, no monthly repayments	Not everyone has enough savings to cover the cost of a car
Personal loan	1-10 years	No	You	No	Simple, you own the car from the start and can sell if your circumstances change	Interest rate can be higher than with other options
PCP	1-5 years	Yes	The finance company (until the final payment is made)	Yes	Flexibility at the end of the term; lower monthly payments	Don’t own the car until the final payment is made, deposit required
HP	1-5 years	Yes	The finance company (until the final payment is made)	Yes	Simpler than PCP, once you make the final payment you own the car (no balloon payment)	Larger monthly payments than PCP, you don’t own the car until the final payment is made
Credit card	Unlimited	No	You	No	No deposit, many cards offer an interest-free period	Interest is usually high at the end of that period, not all sellers accept credit cards, limit may not be high enough to buy a car
PCH	1-5 years	Yes	The finance company	Yes	You can change your vehicle frequently, you’re not responsible for long-term maintenance or depreciation	You never own the car

Considering a personal loan? If you’re looking for a flexible personal loan of £1,500-12,000 to finance a car, you can take a look at our loan calculator or make an application at www.koyoloans.com. Representative APR 27%

Frequently asked questions about different types of car finance

What are the different types of car finance?

We’ve outlined the different types of car finance above – in the UK, there are many options to choose from, each with pros and cons. The most common ways to purchase a car include savings, personal loans, PCP and HP agreements.

What type of car finance is best?

Everyone’s financial situation is different, which is why we’ve put together the table above, listing out the main features, pros and cons of each. The important thing is to compare your options and consider how your circumstances may change in the future.

Can I get a personal loan to finance a car?

Absolutely – a personal loan is a relatively common way to finance a car. For example, Koyo offers flexible personal loans of £1,500-12,000 to finance cars. If you’re interested, you can take a look at our loan calculator or make an application at www.koyoloans.com. Representative APR 27%.

Footnotes:

1. https://www.whatcar.com/advice/buying/is-cash-better-than-car-finance/n22934