Car finance explained

Car finance explained

We aim to help you find the most appropriate car finance option to suit your own individual circumstances. The first step in this process, however, is making sure that you understand exactly what car finance is.

‘Car Finance’ is a generalised term that is used when you pay for the purchase of a vehicle over a set period of time. The payments you make over this time can depend on a number of things including the length of time you plan on keeping the car for, the amount that you are looking to borrow and, ultimately, what type of agreement you have.

With many finance options available, it’s important to understand how they differ and why one option may be more suitable or beneficial to you than another.

So, if you’re not sure how a hire purchase is different from a PCP, or perhaps you’d like more information on how unsecured loans can be used to fund a car – that’s where we can help!

We’ve taken a look at some of the most popular car finance options available to provide you with a simple (and jargon-free!) breakdown of each.

We’re going to look at the following vehicle finance types; Hire Purchase (HP), Personal Contract Purchase (PCP), Personal Loan, Guarantor Loan and Leasing. Every type of agreement is different, each having their own plus points. So here’s everything you need to know to get the best agreement for you.

What is a hire purchase?

Hire Purchase (HP) is the most commonly used form of car finance and, in laymen’s terms, means that you’re hiring the car from the lender until you’ve paid for it in full. If you take out a HP agreement, you will have the option to pay a deposit – although no deposit car finance is also available – followed by regular monthly payments over a set number of months/years. Putting down a deposit would reduce the total loan amount, which would in turn reduce your monthly payments. Once all agreed monthly payments have been made, the car will then legally belong to you and the finance agreement will end. With a HP agreement, you have the option to pay off the outstanding finance at any point by requesting a settlement figure from the lender.

Pros

  • There are no mileage restrictions imposed
  • You don’t need to find the money to pay a large lump sum payment at the end of the agreement
  • Typically receive lower interest rates than some other forms of finance
  • With any HP agreement arranged through us, we carry out thorough checks on the supplying dealership and on the vehicle that is to be financed as an added form of protection
  • When you have paid back half of the full loan amount, you are free to opt for Voluntary Termination, which means that you can ultimately hand the car back

Cons

  • Can be quite expensive for short term agreements
  • The loan is secured against the car – meaning that if you fail to make monthly payments, the vehicle can be repossessed
  • Failure make regular repayments could also negatively impact your credit score

What is a personal contract purchase (PCP)

A Personal Contract Purchase (PCP) agreement is similar to a hire purchase agreement, in the sense that you will pay a deposit followed by fixed monthly repayments over a set period of time (typically 24-36 months). However, at the end of the fixed term you will have the option to either hand the car back, or pay what is known as a ‘balloon payment’ or Guaranteed Minimum Future Value (GMFV) in order to obtain ownership of the vehicle. If you do decide to hand the car back, there will be a clause in your agreement that states what the maximum mileage on the car can be when you do hand it back. Should this mileage be exceeded or should the vehicle be subject to damage that is not classed as general wear and tear, there will be charges set by the lender, with information around these charges being stated in your initial agreement.

Pros

  • Gives you the flexibility to either keep the vehicle or hand it back at the end of the agreement
  • Monthly payments tend to be lower as there is a large lump sum due at the end of the agreement
  • Fixed cost over a set period of time that is secured against the purchase of the vehicle

Cons

  • If you decide to give the car back at the end of the agreement, there will be charges if the vehicle is returned in a different condition to that stipulated in your agreement, for example excess mileage or vehicle damage
  • If you decide to keep the car, you will have to pay the balloon payment/GMFV – typically the equivalent to the estimated market value of the car at the end of the term. However this figure will be given to you before you sign the agreement
  • Interest on the GMFV is included in the monthly payments, regardless of whether or not you are looking to keep the vehicle at the end of the agreement

What is a personal loan

A personal loan (also known as an unsecured loan) enables you to borrow an amount of money over a fixed amount of time in order to buy a car. If you choose to take out a personal loan to buy a car, you will own the car from the time that the dealer receives the money for it. This loan is not secured against the vehicle itself (unlike a PCP or HP agreement), meaning that you can sell the car at any time without needing permission from your finance company beforehand.

Pros

  • As you already have the finance agreed, this could put you in a better position to negotiate on the price of your vehicle
  • This type of loan is not secured against the car, meaning that the car cannot be repossessed and you can sell it at any time during the agreement, provided that you continue to keep up with repayments
  • The interest rate is fixed meaning that your monthly repayments remain the same, allowing you to budget better
  • With a personal loan, you can buy a car from any dealer, or even from a private seller

Cons

  • If you have a less than perfect credit history, you are less likely to get accepted for a personal loan
  • Maximum loan values do not usually exceed £25,000
  • With a PCP or HP agreement we carry out thorough checks on the dealership and vehicle to ensure they are reputable, with a personal loan you have the option to decline these checks

What is a guarantor loan

A guarantor loan is often suggested if the individual wanting to take out the agreement has a particularly poor credit rating. This is because it involves a third party (usually a parent or friend) agreeing that you will keep up the repayments of the loan – if you fail to do so, they will subsequently pay the monthly costs.

Pros

  • Ideal for people who have difficulty in getting approved for finance
  • If you keep up to date with the monthly repayments, it can help to rebuild your credit score
  • Fixed monthly repayments over a set period of time

Cons

  • Typically a higher APR than other forms of finance
  • You must have someone willing to act as your guarantor and agree to pay the monthly costs if you are unable to
  • In most cases, the guarantor has to be a homeowner

Leasing

Leasing involves a long-term rental on a new vehicle. At the start of a lease agreement you must pay a deposit or initial rental payment, which is usually 3 months’ payment upfront, followed by fixed monthly payments over a period of time – typically 2-3 years.

There are two types of leasing agreements; business and personal.

Business contract hire (BCH) involves the contract being in a company’s name, and one benefit of BCH agreements is that the business taking out the agreement can claim back a certain amount of VAT throughout the lease period.

Personal contract hire (PCH) agreements act very much in the same way as business leases, with the exception of the ability to claim back VAT. With all lease agreements, you simply hand the car back at the end of the term, unless a purchase price is requested.

When you do hand the car back, it is subject to mileage and damage checks – the mileage restrictions will be stated in the contract and you will be charged per mile if you exceed these limits. You can add a maintenance cover package to the agreement to cover services such as consumables (e.g battery, coolants, nuts and bolts etc), tyres and servicing – of course this is all contract specific.

Pros

  • You have the option to have a brand new car every few years
  • You never have to worry about the depreciation of the vehicle as you don’t own it
  • As it is a new car you’re leasing, you receive a manufacturer’s warranty that usually lasts a minimum of 3 years

Cons

  • In order to be eligible for a lease agreement, you will likely need a good to excellent credit rating
  • Upon handing the car back, if the mileage or condition of the vehicle do not meet the lender’s expectations – as stated in the contract – you will be liable to additional charges
  • You are tied to the contract in the sense that if you decide you no longer like the car or cannot keep up with the payments, your only option is to cancel the contract which usually involves a minimum 50% charge of your remaining total
  • You cannot modify the car in any way without first being granted permission by the leasing company

This is just a brief overview of the types of vehicle finance available, and hopefully you’re now feeling more informed about your options.

No matter what type of finance you choose, remember that your credit history will be affected if you fail to keep up to date with the repayments, so it is important that you are confident that you can comfortably afford all the repayments before you sign the agreement. You are also free to settle any agreement early, usually by paying a small fee (normally one month’s interest and/or an option to purchase fee).

Our finance options

As we mentioned, the most common form of car finance is that of hire purchase, with this agreement being the most popular with our customers too! Working with a large panel of lenders, we’re able to help customers with credit scores ranging from poor to excellent to secure finance, and at competitive rates too. We can also offer personal loan and guarantor loan agreements, with a number of customers finding these the perfect solution to their car finance needs.

Upon making an application for finance with us, we work hard to find the best finance option available for you. If approved, we’ll then provide you with a no obligation quote and discuss the terms of the finance approval in detail. When you’re happy, it’s time to start searching for your car!

So whether your credit history is poor or excellent we’ll do our utmost to find you the most competitive, suitable finance option available and get you in your new car in no time at all.

Got a question?

If you’ve got a question or want help applying for finance with us, contact our customer services team who can explain everything you need to know!

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Representative example. Excellent Credit

Borrowing £7,500 over 48 months with a representative APR of 16.8%, an annual interest rate of 16.8% and a deposit of £0.00, the amount payable would be: £211.25 a month, with a total cost of credit of £2,640 and a total amount payable of £10,140.

CarFinance 247 is a broker and not a lender