Buying a car is a big financial commitment. With lots of people unable to afford to buy one outright, many drivers will be looking for the best way to spread the cost of hitting the road. In this article we explore the different ways you can finance a car purchase, outlining the features of each option and highlighting the advantages and disadvantages.
Which is the best way to finance a car purchase?
Whether you are buying a new or used car, the choice of finance falls into two main categories: deals you secure through a car dealership or broker, and personal finance options, including credit cards or loans. The best option for you will be determined by a number of factors, including:
- How much cash you have available (to potentially use as part-payment or as a deposit)
- How much you can afford as a monthly repayment
- How important it is to you to legally own the vehicle
- Whether you are happy to have the mileage you travel in the car restricted
- How long you plan to keep the car for
- How strong your credit history is
- Whether you can afford to make a lump sum payment at the end of the finance deal (also called a balloon payment)
In the table below we outline the key characteristics of each car finance method, including whether you need to have money available upfront for a deposit, if there is a balloon payment to make at the end and who owns the car at each point through the finance payment plan.
What are the differences between car finance options?
|Personal contract purchase
|Personal contract hire
|Do you need a deposit?
|Do you have a mileage limit?
|Do you need to make a balloon payment at the end?
|Is the payment secured against the car?
|Do you own the car?
|You own the car after you have made all the repayments
|No - unless you make the balloon payment
*This is usually the case, but there may be some exceptions
What is Hire Purchase (HP)?
The idea of Hire Purchase (HP) is that you, in effect, 'hire' the car for the duration of the finance period, but when you reach the end of the fixed term, you then own it outright. Unlike other options, there is only a small extra payment to make at the end of the deal to transfer the car ownership to you, rather than a large balloon payment. Up until that point, the vehicle still belongs to the finance company.
Hire purchase can be a good option for those who know they want to keep the car for a long time and don't want to worry about racking up excess mileage during the finance period. The length of the finance deal can vary, allowing you to balance the amount you can afford in monthly repayments with the total amount you want to pay overall. The optimum is to keep the duration of the finance as short as possible as you will pay back significantly less.
The key features of HP are:
- It can be used for buying a new or used car
- You typically have to pay a deposit of around 10% of the car's value
- You pay a fixed monthly repayment
- The interest rate will be lower if you have good credit, and significantly higher if you have bad credit
- The repayment period is typically 1-5 years
- You don't own the car until the final payment is made
- At the end of the finance deal, you pay an 'option to purchase' fee that covers the cost of transferring ownership of the car to you
- If you don't keep up the repayments, the finance company can seize the car
For more details on buying a car with HP, read our article 'What is Hire Purchase?'.
What is Personal Contract Purchase (PCP)
Personal Contract Purchase (PCP) can be used to finance both new and second-hand car purchases, but are slightly more complicated than an HP arrangement. In essence, you pay a lower monthly payment as you are only paying back the amount the car will be worth at the end of the deal, factoring in depreciation and the deposit you pay upfront.
PCP is well-suited to those who like to change their car every few years, as most people don't make the balloon payment to keep the car but rather switch to a new PCP deal on a new car.
The key features of PCP are:
- You can get a PCP loan from a car dealership or an online broker
- You can expect to put down a 10% deposit
- Some dealerships will offer to make a contribution towards the deposit in exchange for you taking out their finance deal
- The amount you borrow is calculated by working out what the car will be worth at the end of the finance deal, minus the deposit you have paid (this is known as the Guaranteed Future Value)
- The repayment period is typically 1-5 years
- At the end of the deal, you have the option to make a balloon payment equal to the Guaranteed Future Value and keep the vehicle
- Alternatively, you can exchange the car at the end of the deal and start a new payment plan on a new car, or walk away altogether
- You have to estimate the mileage you are likely to do when you take out the finance deal
If you exceed your estimated mileage amount, you will be charged a penalty of around 10p per mile when you return the car. You will also be charged for any damage to the car over and above normal wear and tear.
For more information on PCP, read our article 'What is Personal Contract Purchase – and is it the best car finance option for you?'.
What is Personal Contract Hire (PCH)
Personal Contract Hire (PCH) is also known as car leasing. It is a form of long-term car rental - you won't own the car at any point and will walk away from it at the end of the agreement.
A big appeal of PCH is maintenance costs, such as servicing and replacing tyres, are usually included in the deal. With road tax also covered by the monthly payment, it offers peace of mind for people who don't want to incur additional costs. The exception to this is the money that will be payable for any scuffs, scratches or dents, as well as a small per mile fee for any mileage above the agreed limit.
The key features of PCH are:
- You won't own the car or have the option to buy it at the end of the finance period
- You will usually need to pay a deposit equal to a few months' worth of monthly payments upfront
- The monthly cost will be determined by the car you choose and the maximum mileage you say you are going to do
- The finance deal typically lasts 2-4 years and, at the end of that time, you return the car
- When you return the car, it will be inspected and you will have to pay for any damage or excess mileage
For a full explanation on PCH, read 'Is Personal Contract Hire the best car finance choice for you?'.
Do I have to buy a car with finance from the dealership?
While you can anticipate a hard sell from the salesperson at the car dealership as they are incentivised to sign buyers up to their finance deals - car finance is an important income stream for dealerships - there are alternatives available. Indeed, it pays to shop around rather than simply accepting the finance deal presented to you on the forecourt.
Outside of HP, PCP and PCH, which we outlined above, personal finance options include:
Buying a car with cash
While buying a car with cash means you won't end up paying interest on the purchase and you will own it outright from the outset, you need to keep in mind that you will sacrifice some of your consumer rights in doing so. By paying as little as £100 of the total cost of the vehicle on a credit card, you are afforded rights under section 75 of the Consumer Credit Act. This means you are protected if the car is faulty, not as described or if the car dealership goes out of business between making the payment and collecting the car.
There is more information in our article 'Section 75 of the Consumer Credit Act explained - your rights and how to claim'.
Buying a car with a personal loan
If you have a good credit history and can secure a deal with a low APR, taking out a personal loan can be a cheaper way to purchase a car than other forms of finance. As with buying a car with cash, you will own it outright from the beginning, which means you will have to foot the bill for costs such as repairs, tyres and servicing. However, you will also have the option to sell the car at any point if needed.
As with using cash, buying a car with a personal loan means you forego the Section 75 rights you would gain with a credit card. You also won't have the same level of recourse if the car is faulty as you would through taking out an HP or PCP agreement, where the finance company is jointly liable. However, you will still be covered by the Consumer Rights Act, which means the dealership has an obligation to make sure the car isn't faulty and is fit for purpose.
If you decide to take out a loan to finance your car purchase, it will work out cheaper to opt for an unsecured rather than a secured loan. With the latter option, although the monthly payments are likely to be lower, the loan will be spread over a longer period, meaning the overall amount you'll repay will be significantly higher. Whichever option you choose, it is worth using an online eligibility checker before applying for the loan, which will give you a good idea of whether you are likely to be accepted without leaving a mark on your credit file.
For a comparison of loan types, read our article 'Secured vs unsecured loans: which is best for me?'.
Buying a car with a credit card
Whether you will be able to successfully purchase a car using a credit card will largely depend on how much the car costs, what your credit limit is and whether the dealership or private seller accepts that form of payment. In theory, if you can get a card with a good 0% interest introductory offer on purchases, it can be a cost-effective way to make the purchase. However, you will need to ensure you pay off the debt during the interest-free period, otherwise you will likely face a much higher APR than you would with other forms of finance.
For our recommendations of the best 0% purchase credit cards, read our article 'Compare the best 0% purchase credit cards'.
Can you get 0% interest on car finance?
It is possible to get 0% finance deals on cars, where the total cost is divided into equal monthly payments, with no interest added. However, while this can be an attractive offer for buyers looking for a cheap and convenient way to fund their purchase, there are certain points to consider before taking out a deal:
- To get a 0% interest finance deal you will normally have to pay a large deposit
- If you take out a PCP deal, while the monthly repayments will be interest-free, you are likely to still have to pay the large balloon payment at the end of the plan if you want to keep the car
- Interest-free finance is almost exclusively available on new cars, which means you will be hit by depreciation as soon as you drive off of the forecourt. It can often work out cheaper to buy a nearly-new car without the benefits of 0% finance rather than a brand-new car interest-free
- It will be more difficult to negotiate on the price of the car if you want to take out the dealership's 0% finance deal
- In many cases the finance is, in fact, priced into the cost of the car, making the salesperson unlikely to agree to much of a discount on the headline price
Can you get car finance if you have poor credit?
If you have an impaired credit score with the main credit reference agencies, it will be more challenging to find a reasonably priced car finance deal. You may not get accepted for some products and, for others, you can expect to pay a premium because of your poor credit history, as well as having to put down a much larger deposit.
Before you begin looking for a car, you will need to do some homework, checking the rates that you are likely to get and the sort of car you can reasonably expect to be able to afford to buy. Where possible, use eligibility checkers to see if you are likely to be able to secure a particular form of finance without risking impairing your credit score further by applying and being rejected. For HP, PCP and leasing options, scrutinise the finance company's terms of conditions to see if you are likely to be accepted and what the additional cost will be.
It pays to check your credit score with Experian, Equifax and TransUnion and make sure the information those agencies have for you is correct. For advice on how to improve your credit score, check out our article 'How to improve your credit score quickly'.
If you are unable to secure conventional car finance, you may wish to consider:
- A secured loan - as the loan is secured against your property, it reduces the risk for the finance company. However, there are serious implications if you can't keep up with the repayments as you could lose your home. You will also typically pay a lot more in interest as the loan will be over a longer period.
- A guarantor loan - as with a secured loan, with a guarantor loan a friend or family member puts up either money or property as collateral for the loan, agreeing to take on the responsibility of the debt if you miss payments. Again, this is not a product to be taken out lightly, with serious ramifications if the arrangement breaks down. There's more information in our article 'What is a guarantor loan - should you take one out?'.
Summary - which car finance should you choose?
The simple answer is that there isn't a one-size-fits-all approach to financing a car purchase. Much will depend on the type of car you want, the amount you are willing to pay for it and whether it is important to you to own it outright. By working out these factors before you start looking for a car, you can ensure you choose the best option for your circumstances and reduce the risk of being sold a finance deal alongside the car you like without fully considering whether it is the right choice.
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