How does car finance work?

Buying a car is a necessity for some people, and for others it may just be convenience. Where public transport isn’t great, cars are usually the first port of call for travelling from A to B. While the reason for having a car might be straightforward, knowing how to finance one can be a little more tricky. With abbreviations like HP and PCP and some policies requiring deposits up front and others wanting balloon payments at the end: car finance is not as simple as it sounds. Plus, you may want to consider the alternative ways to finance a car.

Types of Car Finance

While in some cases you may need quick cash in order to secure a good deal, most times, buying a car is a longer process that starts well before you actually need access to the new vehicle. You may need to research different brands, weigh up the pros and cons of different models, or consider whether sticking with your current car is a more affordable option. During this time, it’s a good idea to look at car finance options available and start saving towards your new purchase. Even with hire purchase and PCP agreements, you might still need a deposit and it’s one less thing to worry about if you can save these funds in advance.

Personal Contract Hire

Personal contract hire is another term for leasing, and it works in the same way as renting a house: you make monthly payments and while you will have full use of the vehicle, you will never actually own it. Leasing often requires a deposit up front and the length of agreement is typically 1-4 years. You’ll have a maximum annual mileage and standard wear and tear usage, but any damage or miles over the agreed limit may be subject to a fee at the end of the term. Leasing is a reasonable way to finance a car, but it’s worth remembering that at the end of the agreement, you won’t own the car or receive any funds from resale.

Personal Contract Purchase

Personal contract purchase works in a similar way to leasing, but you have the option to make a balloon payment at the end of the agreement in order to own the vehicle. In most cases you will still need to make a deposit, and you likely have a maximum annual mileage limit too, even if you intend to purchase the vehicle at the end of the agreement. PCP can last up to 5 years and might be a good option if you’re not sure you want to buy a new car as you aren’t tied into the purchase. Like leasing, you have to make a monthly payment and you won’t own the car until the final balloon payment has been made.

Hire Purchase

Hire purchase is a bit like leasing in that you make a monthly payment but unlike leasing, at the end of the agreement, you do own the vehicle. You effectively borrow the money from the lender to buy the car, and then you make monthly repayments to the lender to repay the loan. Again, you don’t own the car until the final repayment, and you’ll probably need a deposit, but there are no mileage limits and no penalties for damage from the finance company. HP finance is like a secured loan, the security being the vehicle itself, which means lenders can offer the service to a wider customer base, so it may be a more accessible option if you’re struggling to get a loan to buy a car.

Top tip: When using car finance, carefully read your insurance policy before signing the agreement. If you get into an accident and the car is written off, the insurance company may pay the finance company the remaining balance, leaving you without a car and without any funds to get a new one.

Using alternative types of credit

You should always choose a type of credit which is suitable for the reason you need to borrow. Even the best instant loans won’t help you buy a house! While some credit uses are quite flexible, other credit facilities are designed for specific purposes, and it can make sense to take advantage of these. That being said, there’s no harm in looking at the alternative credit options available when it comes to buying a car, because even though there are dedicated car finance options, it could be cheaper to use a different credit facility.

Personal Bank Loan

If you have a good credit history, you might be able to get a low interest loan from a bank. Typically, a personal loan is between £5,000 and £15,000, which can make them a reasonable option if you’re looking to buy a used car – it’s unlikely you’ll get a brand new car for less than £15k. The average interest rate is just over 9%, though this will vary from bank to bank and if you compare loans online you may be able to find a much cheaper option. You can normally borrow for up to 7 years as well, which often makes the monthly repayments more manageable, though you shouldn’t borrow for longer than you need to. Using a loan like this means you will own the vehicle from the start, but it’s worth noting that the bank may repossess the vehicle or other assets if you fail to keep up with your repayments.

Credit Card

Often, we think of credit cards as being used to help with day to day cashflow and unexpected expenses throughout the month, but credit limits can be up to £10,000, if not more, which means you could use the funds to buy a car. If you have a 0% credit card, and you make at least your minimum payment on time each month and you repay the balance within the 0% timeframe, you won’t be charged any interest for your borrowing. It’s probably therefore the cheapest type of credit you can use to buy a car if you can repay within the 0% timeframe. If you don’t have a 0% interest rate credit card, you will need to do some research to find out whether it would be cheaper to use a credit card compared to other car finance options. You may also want to check that the dealership accepts credit cards.

Can I use a same day loan to buy a car?

Same day loans are popular because you can access the funds on the same day that you apply, as long as you are approved. But you might not need access to fast cash, especially if your reason for borrowing will take time to process, like when buying a car. In addition, payday loans tend to be for relatively small sums, and while they might be appropriate to manage an unexpected car repair, it’s unlikely they will be able to provide you with sufficient funds to buy a new car altogether. Plus, the interest rates are classed as high interest which means they’re not the cheapest way to borrow – even if you have bad credit. So, although they can be convenient, same day loans aren’t necessarily a suitable way to finance a car.