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How does car finance work? – Car finance options explained

When buying a car, people may occasionally need to rely on car finance. For someone new to car finance, the sheer options and choices available can be quite overwhelming, so in this blog we look at explaining some of the options available.

But first, a quick summary of car finance interest rates. These will vary depending on the finance in question, but the best offer on the table will typically one which is 0% APR. This means you can avoid paying interest, as long as you have the finance available to cover the typically short term period.

Car finance option 1: Personal loan

When looking at the best car finance options for you, you may opt for a personal loan with your own bank. If you have been an established customer for a number of years, this interest rate will often be a lot more competitive than you can find elsewhere.

The longer the period of your loan, the more you may find yourself paying.

Of course, with any car finance option, there is a downside to this. If you do not keep up with your repayments, you face the prospect of having personal assets seized. On dealer finance, it would only be the car that is vulnerable to repossession.

Pros:

  • competitive rates
  •  customer exclusives often available
  •  personal to you

Cons:

  • personal assets vulnerable if you don’t make your repayments

Car finance option 2: Hire purchase (HP)

A second option and a good way to spread the cost of car buying is hire purchase (HP).  Under a HP agreement you pay monthly instalments to eventually purchase the vehicle.  Unlike other forms of finance however, under payment you do not own the car until you have fully repaid the loan.

With HP, you are typically obliged to pay a deposit of around ten per cent; following payments are then made throughout the term of the agreement.

An alternative to paying a deposit is to opt instead to make a balloon payment at the end of the agreement.  What’s a balloon payment? Basically it is the repayment of whatever sum of money is outstanding at the end of the loan. So if you had picked a £10,000 car and over the course of the loan paid off £6,000 – the final payment would be £4,000. The alternative to balloon a payment is to pay a deposit

As with the dealer finance, the car is the only vulnerable asset in this scenario.

Pros:

  • Dealer finance options are typically offered then and there – no need to look around
  • Easy to understand, pay a deposit and then regular payments
  • Terms of up to five years

Cons:

  • Monthly payments may be higher than other finance options
  • Car is not yours until finance is settled

Car finance option 3: Personal contract purchase (PCP)

PCP is an increasingly popular method of purchasing a car on finance these days. As with most types of finance you will be required to pay a deposit and regular monthly payments, but where this type of car finance differs is in the final options. Under a PCP finance deal you can opt to return the car to the dealer, keep the car (and pay a final balloon payment) or alternatively trade the car in for another car.

Pros:

  • As with HP, can be offered then and there by dealer
  • New car that can be changed when finance term is complete
  • Shorter term than HP

Cons:

  • You may get caught in a cycle of changing the car every few years to avoid the balloon payment

PCP is more heavily reliant on a solid estimate of your mileage, so if you’re not sure you can accurately gauge this, you want to err on the side of caution as going over the agreed upon mileage will result in higher costs

There are of course other methods of financing the purchase of a car. You will need to bear in mind the impact a bad credit can have on any finance opportunities. There are also other opportunities out there such as Peugeot’s Just Add Fuel. Similarly, there may be opportunities for deals on car finance for young drivers or the unemployed.

What’s the best car finance option for me?

If you are sure you want the car for a long time, either the personal loan or HP options are better for you. On the other hand, if you want a new car every couple of years, then the PCP option is the best route.

If you don’t have the patience to find the best deals, dealer finance options cut out this hassle, but if you have been a customer of the banks for a number of years, many will offer special competitive rates, better than dealer options so this is worth keeping in mind.

Ultimately, you have control over buying the car, so if you have a set budget in mind, and make sure you know what option is best for you prior to entering the dealership, you will set yourself in a much better position to negotiate.

Car finance options explained

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