What is car finance?

The majority of adults in the UK have access to a car. Even if you don’t drive yourself, your spouse or family member probably does and unless you live in an area with great public transport, cars are a necessity for many. From driving to work to doing the weekly food shop, we all need to get around but if that car or van breaks down, you could be left stranded and in need of a new one.

So, if you do find yourself in a need of a new car one of the first places you are likely to look is a car dealership – whether that’s at a garage or online. Almost every dealership in the UK offers ‘car finance’ once you make it clear that you are very interested in a specific car.

Car finance is a broad term covering hire purchase agreements (HP) and personal contract purchase (PCP), although it can technically be used to describe any method used to buy a car.

Hire Purchase (HP)

A Hire Purchase Agreement (HP) is a form of leasing – essentially, you rent the car for an agreed period of time. You usually pay a deposit at the start of the agreement, and then you will make regular payments every month for the duration remaining. Financing a car with a HP agreement means you will own the car once the final repayment has been made which does mean it can be more expensive than PCP because your repayments must cover the entire cost of the car.

While you will probably pay interest on the amount you have borrowed, it is a recognised way to spread the cost of the car if you can’t afford the full payment upfront. However, always make sure you look around and compare finance providers as the interest rates can vary, and as you may be borrowing a large sum over a few years, even a difference of 1% APR could save you hundreds.

If you’re not fussed about which car you buy, try to find a dealership that offers 0% APR on car finance as this means you won’t pay anything for borrowing the money to pay for the car.

Personal Contract Purchase (PCP)

Some people will only ever use PCP to lease their cars because it works for them financially, and it means they get a new car every 3 years or so. The main drawback is that you don’t own the car. This means if you miss your repayments, the financer can repossess the vehicle. It also means that if you write the car off, you might not receive a pay-out from your insurance company: they tend to pay the car finance provider as they are the ones incurring the financial loss.

The monthly payments tend to be more affordable on PCP than with hire purchase agreements because the balance is calculated based on what the vehicle will be worth at the end of the agreement and as you are handing the vehicle back, you don’t need to cover the remaining balance. However, if you do want to own the car at the end of the agreement, you usually have to pay what’s known as a balloon payment, which is essentially a large final deposit. PCP could work in the short term, but it’s quite an expensive way to finance cars over a long period of time.

Alternatives to Car Finance

There are loads of ways to finance a car:

Credit Card

This is great if you have a low interest rate and a high credit limit. It means you can spread the costs of the repayments to suit the ebb and flow of your finances and you will own the car outright.

Personal Bank Loan

Once the money is transferred, you will own the car so it will become a financial asset. However large bank loans are usually only accessible to those with a high credit score, so you may need to look around if your credit history is less than perfect.

Using your savings

This is by far the cheapest way to buy a car and become the owner. You won’t pay any money in interest repayments and the car is immediately yours, without owing a thing to anyone else, but it may take you longer to buy the car as you have to wait until you’ve saved the money for it. Top tip: even if you can’t save enough to buy the whole car, try to save as big a deposit as you can so you reduce the amount you need to borrow.

Remember that buying a car, whether on car finance, or using one of the alternatives listed above, involves many different factors. You need to budget for insurance, road tax, MOTs and services. If your car doesn’t have an MOT or it’s not taxed and insured, you could face severe fines and penalties on your license which make insuring the car more expensive the next time round.

However you decide to finance a car, do your research first. You don’t have to use the car finance provider that the dealership offers and it’s not always the cheapest either. Before you buy a car or decide on a model, check out the road tax and get an insurance quote so you’ll know if you can afford to buy that particular car. Older cars might be cheaper to buy but the road tax will be more, and brand new cars will be much more expensive, but you may get 3 years of MOTs and servicing thrown in for free. Shop around and don’t be afraid to ask what else the dealership can offer – the worst they can say is “nothing”!