It’s important to know the best way to finance or loan a car and the purchasing option that best suits your budget.
As well as a vehicle’s upfront cost, there are also other factors you need to think about when purchasing a vehicle. From running costs to repairs and insurance, there’s lots to consider when working out the cost of your vehicle.
You’ve got several options when purchasing your new car, such as taking out a personal loan or car finance. Which is best for you depends on your budget and whether you want to own your vehicle outright or give it back eventually.
Listed below are some of the most common methods used when buying a new car, so you can decide if a personal loan or car finance is the right choice for you.
Personal Loan
One option to finance your car purchase is a personal car loan, which involves borrowing money from a lender. You can use the borrowed sum to purchase the car outright, but you’ll need to pay the lender back at the rate you agreed.
How does it work?
If your credit rating isn’t bad, you should be able to secure good terms on a car loan. There are a few ways to arrange a loan such as:
- Over the phone with a lender.
- Online on a lender's website.
- Face-to-face at your bank or building society.
Directly approaching lenders may lead to being offered better rates than a dealership too. Once your loan is approved, you can use the money to purchase the car. Taking a loan out this way means you own the car, but you’ll owe the lender for the money you’ve borrowed.
Before agreeing to any terms or making commitments, ensure you know how much you’ll owe the lender. Consider things like:
- Interest amount.
- Repayment duration.
- Whether you can afford the payments if circumstances should change.
It’s important to ensure you can pay the total amount even if the worst should happen. There are always other options if this isn’t comfortable for you.
If you’ve had difficulties securing credit in the past, a homeowner loan may be a better alternative. This loan is secured against your property, which means you may be offered a lower interest rate. However, if you fail to meet the repayment terms your home could be repossessed. While it requires careful budgeting, if you manage to meet the repayments you could improve your credit score.
While unsecured loans don’t use your home collateral, they often come with shorter repayment periods and high interest rates.
Pros of a Personal Loan
When comparing personal loans vs car finance, there are several personal loan pros to consider:
- Quick access to funds to buy the car outright.
- You own the vehicle rather than lease it.
- Interest rates can be reasonable with good credit.
- With so many loans on the market, it’s easier to find one to suit you.
Cons of a Personal Loan
While there are many advantages, there are also some drawbacks to consider before taking a personal loan:
- They can be difficult to secure with poor credit.
- If you sell the car, it’s scrapped, or becomes damaged you still owe the full loan amount.
- Your vehicle’s value depreciates, meaning you’ll lose money against how much you borrowed. This applies to most financing options apart from Leasing. See information on leasing later.
- A loan may be secured against your house, meaning it could be claimed in lieu of payment.
Hire Purchase (HP)
Hire Purchase – also known as HP – is a popular way of purchasing a new car. Generally, you pay a deposit on the vehicle (usually valued at 10% of the car’s total value) then pay the remainder in instalments. Repayment terms usually vary from one to five years.
How does it work?
Most hire purchase agreements are normally with the car dealership, where you’ll agree a repayment period then pay off the car’s value over that time. It’s worth considering that with longer repayment periods comes higher total interest.
This type of loan tends to use your car as collateral, meaning your vehicle will be repossessed if you do not meet the agreed repayment terms. Additionally, you will not own your car until the end of your loan agreement. Once complete, you’ll have two options: return the vehicle to the dealership or pay a small option to purchase fee of typically £100 to £200 to own the car outright.
Before committing to a car hire finance or loan, you should ensure the total amount repayable is comfortable for you, even if your earnings were to change.
Halfway through the repayments, the dealer may allow you to return the car without subsequent payments, this is called voluntary termination. However, this could negatively affect your credit score. If this is a concern, it’s worth asking the dealership before signing any paperwork.
Pros of a Hire Purchase
When determining whether to get a personal loan or car finance, it’s worth understanding some of the pros of purchasing a hire contract:
- You can pay a set amount per month.
- You can usually spread the costs over one-to-five years.
- You own the car at the end of the agreement subject to payment of the small option to purchase fee.
- Sometimes, you can end the agreement after half the repayments have been paid off. This is not usually advisable because of the possible effect on your credit rating.
Cons of a Hire Purchase
While there’s plenty of pros, there’s always cons to consider which may affect your decision, such as:
- You won’t own the car while the agreement is outstanding, which means you can’t sell it unless you repay the hire purchase in full.
- If you can’t keep up with repayments, your car may be repossessed.
- You can only secure affordable car hire terms if you have a strong credit history.
Personal Contract Plan (PCP)
A Personal Contract Plan (PCP) is an affordable way to finance your car, and is seen as a low-cost alternative to hire purchase. As with a hire purchase, you’ll pay a deposit equalling 10% of the car’s value then repay the rest monthly to lease the car for one to five years.
The main difference is that you will have a substantial payment to make at the end of the agreement should you want to take full ownership of the car, this is called a balloon payment and will factor in depreciation of the car, including mileage and wear and tear.
How does it work?
With a PCP, you’ll pay a monthly amount to lease the vehicle, which also includes the option to purchase the car at the end of the agreement for a lump sum payment or hand it back.
However, the dealer will base the loan on a projection of the value of the car at the end of the hire period. The total sum you pay covers the gap between your deposit and the car’s projected future value.
As an example:
- The car’s original value is £30,000.
- The predicted value after 5 years is £15,000.
- Your deposit is £3,000 (10% of the original value).
- And your total payment would be £12,000 (the £15,000 predicted value minus the deposit).
- This does not include any additional interest charged.
Once that payment term is complete, you’ll then have the choice of buying it outright or handing the car back.
Pros of a Personal Contract Plan
There are a few pros to a Personal Contract Plan. To recap, they’re:
- More affordable than most other arrangements.
- Can include services and maintenance from the dealership.
- You can hand the car back without additional charges.
Cons of a Personal Contract Plan
However, there may be cons depending on what you want, such as:
- You don’t own the vehicle outright.
- PCP arrangement may include restrictions on mileage or vehicle usage.
- Your car may eventually be worth less than the dealership’s prediction, leaving you out of pocket if you purchase the vehicle.
- You are charged for any damage the car incurs during the lease period.
Personal Leasing (PCH)
If none of the above options suit you, there’s also PCH or Personal Contract Hire. Just like many other finance or loan options, you’ll pay a deposit along with monthly instalments.
There’s one key difference though: you will not be able to purchase the car at the end of the lease agreement. Additionally, the deposit can be up to six times the monthly payments.
How does it work?
You’re usually able to choose flexible repayment terms between 12 to 36 months, with servicing and maintenance often provided. Your vehicle will also be protected against value depreciation.
However, PCH agreements do include restrictions on car usage. Both in amount usage, and when you’re able to drive.
Pros of Personal Contract Hire (PCH)
There’s many benefits to PCH that may outweigh the negatives, depending on what you’re looking for. Some benefits include:
- Repairs and maintenance are often included in the agreement by the dealership.
- Because there’s no option to buy, there’s no charge waiting at the end of the agreement to buy the car.
- You don’t have to worry about the vehicle depreciating in value.
- Payment terms may be lower due to the higher upfront cost.
Cons of Personal Contract Hire (PCH)
Many PCH agreements are aimed at businesses and may not include the 20% VAT in the pricing. Before signing or agreeing to any terms, make sure you understand and have read the full details. Other cons include:
- Limits on the car’s usage amount and times.
- No option to buy the car outright even if you wanted to.
- A higher initial deposit which may not be suitable compared to other finance options.
Cash or savings
The most cost effective and secure way to finance your new car is to pay for it outright. No interest, no monthly charges and full ownership without restriction. However, having the money available is another matter entirely.
Even second-hand cars can carry a hefty price tag, and for many buying outright may be unachievable. While interest rates are relatively low, it’s likely that most people won’t see huge returns from savings either.
However, that means it may be an ideal time to use those savings to purchase a vehicle outright or pay a deposit. It’s a big decision though, and it’s rarely wise to spend all your savings at once.
One other alternative could be to use a 0% credit card, but this relies on your seller accepting credit card payments. If they do, and your credit limit is big enough, you could get an interest-free loan for as long as 20 months. Additionally, you could be covered by credit card purchase protection – an ideal layer of security when buying from second-hand dealerships.
There’s one caveat though – if you miss repayments, they can go up and become incredibly expensive. That means budgeting to pay off your debt is very important.
Pros of cash or savings
There’s a lot of pros to paying with your cash, credit card, or savings compared to a personal loan or car finance, such as:
- The car is owned by you, and not leased from a company.
- You have no monthly payments to worry about (but may owe money if paid on credit).
- No threats of repossession as the vehicle is yours.
Cons of cash or savings
It’s not the best option for everyone however, or more people would do it. There are cons to think about, like:
- You’ll need to cover the cost for repairs, maintenance, and any damage.
- Your vehicle will likely depreciate in value, meaning selling your car for less than you bought it, but this applies to most purchase options apart from leasing.
- The initial costs are significant and may be unachievable.
- If you pay by credit card and miss your repayment period the charges can ramp up quickly.
Read our Know How blog for more on financing life’s big decisions.
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