Car finance explained
By Adrian Porter
Hire purchase, personal contract plan (PCP) or personal loan: which is best for you? We explain your car finance options to help you decide.
When you’re buying a car, almost every dealer, car broker or car supermarket will offer you a finance scheme – it’s a major source of profit for the motor trade. We explain the different types of finance plan, how to understand your payment options and the advantages of each, as well as the things to be aware of before you sign on the dotted line.
But there are also other ways to pay for your car that could be cheaper than dealer finance and suit you better, such as a credit card, personal loan or other form of independent borrowing. We look at all the options available to help you make the best decision for your needs and financial circumstances.
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There are three main types of finance a dealer is likely to offer:
Hire purchase (HP)
- This is secured against the vehicle itself and you do not own the car until you have made the final payment – you can’t sell it without the lender’s permission, although you can return it. You typically pay a deposit (often 10%) and then repay the balance in instalments, plus interest, over the loan period. At the end of the loan period, you own the car outright.
- Be aware that: the car can be repossessed if you miss a payment. It can prove more expensive than an independent bank loan. Servicing may be included, but check all terms and conditions.
Personal contract purchase (PCP)
- This typically involves paying a deposit then low monthly instalments over a fixed period. At the end of this, you can either pay a lump sum (‘balloon payment’) to purchase the car outright, return the vehicle or sell it privately to pay off the remainder. This suits people who want to change their car frequently, and is based around a ‘minimum guaranteed future value’ (MGFV) for the car.
- Be aware that: it’s important to stick to the agreed mileage limits and to keep the car in good condition to avoid penalties. You are hiring the car and will not own it until the balloon payment is made. It may be less cost-effective than HP if you plan to keep the car, however.
Personal leasing (contract hire)
- This is like a PCP, again with low monthly payments, but you have no option to buy the car. However, it is convenient and it’s easy to change the car. The type of car, length of contract and agreed mileage limits determine the overall leasing cost. You normally have to pay up to three months’ rental in advance.
- Be aware that: although servicing may be included, a large upfront deposit is usually required. Again, mileage limits may apply. Make sure you compare deals taking into account APR, the monthly payments over the loan period, and the total amount repayable, as well as any further ‘option to purchase’ and administration fees.
‘0%’ deals are often offered, usually to shift an outgoing or slow-selling model. These can work out affordable, with no interest charged on your monthly repayments. Bear in mind that they typically require a large deposit (35% or more) and that you’ll be unlikely to negotiate any further discounts. And if you miss any payments, you’re usually switched to a scheme with a higher interest rate.
Dealers also make commission from additional insurance and other products that they may offer as a package with the finance plan. These typically include:
- Gap insurance or ‘asset protection’ - This covers the ‘gap’ between the current market value of your car and the value of your outstanding loan or the cost of replacing your car, should it get stolen or written off.
- Minor damage insurance - Additional insurance covering scrapes and cosmetic damage, which could affect the guaranteed value of your car when you come to return it at the end of a lease plan. You may also be offered separate cover for alloy wheels and for tyres, perhaps as part of a ‘bundle’ of policies.
Invariably, these products are more cheaply bought independently, should you wish to buy them, from a third-party provider. If you find it simpler to buy them as part of your purchase, then at least ask for a discount.
Many Which? members prefer to buy their cars outright using cash – a simple and straightforward way to purchase, and to manage your finances on an ongoing basis. If your savings aren’t quite healthy enough for this, independent finance could be a way to make a one-off payment to a dealer.
- You could borrow the amount you need to pay for the car outright, then pay it back to your bank or other lender. The APR may be high, but you will not have to pay a deposit, you could spread the loan over a time period of your choice, and you will own the car from the outset. It may work out cheaper in the long term than a dealer finance scheme.
- Be aware that: good loan terms will only be available to people with a clean credit rating. There may be penalties for settling the loan early. As with paying by cash, you bear the brunt of the vehicle’s depreciation.
To find the best loans currently available visit our guide to the cheapest personal loans.
- You could buy a car on a credit card just like any other large purchase, as long as your credit limit is sufficient.
- Be aware that: you will have to be disciplined about paying this off. The APR may be high. Not all dealers will accept credit cards, and may impose extra fees if they do.
- Some buyers prefer to borrow more on their existing mortgage to pay for a car, which can make sense as interest rates on mortgages are currently very low. This can also be easier to manage than separate borrowing.
- Be aware that: if you miss payments or run into difficulties, your home is at risk. Borrowing this way could cost you more than other options because you will be paying interest on the loan for the life of the mortgage.
Avoid PPI You’re now unlikely to be offered PPI (payment protection insurance) following the long-running mis-selling scandal. PPI was sold on the basis that it would cover your finance payments if you were unable to work due to accident, sickness or unemployment, but proved expensive and gave limited cover. Should lenders still try to sell you this, we strongly advise against it.
How to getting the best car finance deal
In a time of falling margins, it’s no surprise that selling finance deals is important for car dealers – some are thought to earn more from these than from selling the cars themselves. This does mean that there’s room for negotiation though. Follow our tips below to get the best deal possible.
- Know the rate - The key figure to understand is the APR (annual percentage rate) - the interest you’re paying over the term of the finance agreement. Check how this compares between the different payment plans you’re offered and compare it to the rate charged on a personal loan you might qualify for. Make sure you take into account different timeframes and any fees or other payments you will need to make.
- Think long term - Low monthly payments may be enticing, but consider the cost throughout the whole period of the finance scheme (using the APR and the total amount repayable). A longer repayment term means you will be paying interest for longer and the car could cost you more in the end.
- Shop around Different dealers, even for the same brand, may be able to offer you different finance plans, perhaps in conjunction with a discount on the vehicle itself. Look in terms of the whole deal on the table.
- Have a haggle Armed with the above knowledge, you are in a good position to negotiate over APR – a reduction in this could save you £100s over the course of a year, and even £1000s over the course of the finance plan. Negotiate over ‘deposit contributions’ too,which are manufacturer-funded incentives, as well as discounts in the topline price of the car
- Take your time - Don’t be pressured into signing anything straightaway: get all quotes in writing, and take them away to have a closer look at all the terms and conditions before you finalise the deal.