How does car finance work
How does car finance work
Aside from your house, your car is probably the most expensive purchase you’ll ever make. So how are you going to pay for it? Our guide looks at the different options.
Pay with cash or savings
If you’ve got cash in an account somewhere, it won’t be earning much interest. It might be more cost effective to use it to buy your car, rather than taking out a loan or finance plan. Even if you don’t have enough to buy the car outright, you could still put down a larger deposit to reduce your monthly instalments.
Join a hire purchase scheme
Finance plans are extremely popular. According to the Finance and Leasing Association, 88% of new private cars bought in 2017 were paid for with some kind of finance scheme.
Hire purchase is usually available direct from the car dealership, which makes the process easier. You’ll have to put down a deposit (10% is standard) and the rest will be divided into monthly payments over a fixed term (usually between one and five years).
The advantages here are that the interest rate is usually fixed, which means you’ll know how much to budget each month. And if you’re buying a new car, you may find you get a better deal compared to buying a used car. The downside is that new cars depreciate quicker.
One of the main drawbacks of hire purchase is that you can’t modify or sell the car until you’ve paid it off. Also, how much you pay back will depend on your initial deposit and the length of the payment period. A small deposit and short loan time will mean bigger monthly payments. But a longer loan period may well mean that you pay more in interest.
Always look for deals such as 0% finance. These are especially good if you can pay a big deposit – that way your monthly instalments will be interest free and the repayment period shorter. You’ll also need to weigh those up against the cost of running a car.
Lease your car
If you want the convenience of not having to deal with warranties, maintenance and services, this may well be the option for you. It’s called a personal contract hire (PCH) agreement, and the arrangement is simple: you pay a monthly rental fee, then at the end of the period, you give back the car.
A PCH plan will usually mean paying three months’ rental in advance. Some plans also include a maintenance package, meaning you don’t have to worry about services or even car tax. Your monthly payments will be lower than they would be with a hire-purchase scheme – but that’s because you won’t own the car at the end of the contract.
You’ll also be given the choice of an annual mileage allowance and might find you have to pay an additional amount if you exceed it. If you rack up a lot of miles each year, this may not work for you.
Another way of financing a new car is the personal contract purchase (PCP) agreement. This is a flexible deal with low interest rates and monthly payments, which often gives you the option of buying the car at the end of the rental period. If you do, you’ll be asked to make a bigger final payment at the end, called a ‘balloon’ payment.
PCPs can be a great way to own a new car for the short term. And if money gets tight, you have the security of knowing you can always hand it back. And if you decide not to buy the car, you can part-exchange it for a new one.
Put it on your credit card
Thanks to Section 75 of the consumer credit act, any credit-card purchases costing over £100 and less than £30,000 are protected for free. So, if you buy the car and something goes wrong with it, your credit card company may be able to help.
A 0% interest on purchases credit card can be a great way to buy your car – as long as you pay it off before the end of the interest-free period or move the balance to another 0% card (although this will likely incur balance transfer fees).
But the real downside to credit cards is that some dealerships won’t take them, while others can charge you an admin fee for using a card.
Take out a personal loan
If you have a good credit history, a personal loan is one way to buy your car. The advantage of taking out a personal loan is that you’re able to spread the cost over a long period – sometimes up to seven years. Unlike with hire purchase, with a personal loan you’ll own the car, making it yours to do what you like with.
But you’ll need to keep up your monthly repayments. If you don’t, the bank will take whatever has been secured against the loan – most likely the car.
Compare the annual percentage rates (APR) on personal loans to any finance plans the dealership is offering. The APR is the combined cost of the interest and other charges, which will tell you how good the deal really is.
What else do I need to know?
Once you’ve decided how to fund your car, the first thing you’ll need to do is insure it. At Compare the Market, we make that simple. Just tell us a bit about yourself and what you’re buying, and we’ll do the rest.
We’ll search deals from a variety of insurance providers’ products to find the right one for you.