Car finance

What is car finance?

Car finance is a way to borrow money so you can drive away a car at once and repay that money in monthly payments over several years.

Car finance covers several different financial products. You could use car finance for a brand new car, or a second-hand car.

You will usually make a non-refundable down payment (deposit), and monthly payments (including interest) to the car finance company during your contract. There may be other costs to pay, such as an optional final payment to the lender if you decide you want to keep the car at the end of the contract.

Some car finance products also cover extra costs such as road tax (officially called vehicle excise duty), breakdown insurance and maintenance.

What is second hand car finance?

Second-hand car finance helps individuals and businesses purchase used cars on finance so they can spread the cost of payment. According to Statista, more than twice as many used cars than new cars were purchased on finance between October 2021 and September 2022.

Is it worth getting a car on finance?

It may be worth getting a car on finance if you don’t have the cash to pay for a car up front, or you’d prefer monthly payments instead of one lump sum. But there are downsides too, including mileage limits with some agreements.

If you’re looking for a car finance deal, also known as vehicle finance, auto finance or an auto loan, these agreements have their pros and cons, and we outline a few of these below.

Car finance options

You will need to calculate all the costs involved in each of the car finance options to workout which is best for you. That includes the interest rate plus any fees that might be charged. Here are some of the main car payment plans available when buying a new or used car:

Personal contract purchase (PCP)

With a personal contract purchase (PCP) you pay a deposit to the lender and then a set monthly amount for the term of the contract, which is usually three years. At the end of the term, you won’t have paid off the full price of the car and interest.

You may then pay an additional sum to cover the extra amount and keep the car. That is known as a balloon payment. Alternatively, you can hand back the car and walk away, or start a new contract for a different car.

The lender calculates the amount you pay by looking at what’s called the guaranteed minimum future value (GMFV). This is the amount of money it predicts the car will be worth at the end of the contract. If you decide to keep the car, you will need to make a balloon payment, which will be the difference between what you have paid already and the GMFV.

Hire purchase (HP)

Hire purchase (HP) contracts work in a similar way to PCP in that you pay a deposit and then monthly repayments – but there’s a key difference. With HP you pay higher monthly payments so you cover more of the cost of the car and interest. At the end of the contract, you make one final payment and you keep and own the vehicle.

There is also an option to return the car and end the contract early, but you can only do this if you’ve already paid for at least half of the value, or you can make up the difference between this amount and what you’ve already paid. This amount is capped by law, under the Consumer Credit Act.

Personal contract hire (PCH)

Personal contract hire (PCH) is vehicle leasing for individuals rather than companies. With a PCH agreement, you are renting the car and it will never be yours to own.

The monthly payments are usually more than with other car finance deals, as you don’t pay an initial deposit or final balloon payment. Most require you to pay for at least the first three months up front and there are limits on how many miles you can drive.

You can also pay extra for a maintenance package and this will cover routine maintenance costs and breakdown cover, which can be handy for budgeting.

Conditional sale (CS)

Conditional sale (CS) agreements allow you to borrow the money for a new car from a finance provider a lot like HP finance but with no extra fee to pay at the end to become the legal owner of the car.

You pay a deposit, then borrow the rest of the purchase price, and you pay it back, with interest, over the length of your contract. When you’ve paid back the loan, the car is yours to keep.

Personal loan

You can take out a personal loan from a bank or other financial institution and use this money to buy a new car. The car is yours from the start and instead of paying a car finance provider, you’ll repay the bank through monthly payments, with interest.

With a vehicle loan you can borrow the cost of the car including the deposit, or pay some of the cost of the vehicle from your savings and borrow the rest.

Personal loans can be secured or unsecured. Secured loans are guaranteed against something you already own, such as a property, which is at risk if you can’t make the repayments on the loan. Unsecured loans are not based on any other big asset you own. They are based on your credit score and income.

0% APR deals

Car dealers often promote 0% APR deals, which are vehicle finance agreements without any interest charged. However, it’s important here to compare the overall cost. A contract may not have any interest but if the monthly repayments are higher, it could be cheaper to choose a contract with a low interest rate.

Car finance options compared

Here is a simple table to help you compare car finance options. It’s worth noting that these vehicle finance plans also apply to vans and motorcycles.

Things to consider when applying for car finance

Before you apply for car finance, consider how much you can afford, and the type of deals that may be available to you.

Understanding your financial situation

You must first have a clear understanding of your financial situation. Everyone has a credit score, which is based on how you manage your finances. It is calculated by looking at how much credit you are borrowing and whether you make repayments on time. And it asks if you are on official databases such as the electoral roll.

Whenever you apply for credit, the potential lender will examine your credit score to decide what interest rate (APR) to charge you, how much to lend you, and even whether it will lend to you at all. If you have a low credit score, you may be offered a higher interest rate and possibly a smaller amount of money than someone with a good credit score.

You will also need to consider your overall budget and if you can afford the loan repayments for the contract term. If during the contract you lost your job, for example, would you still be able to make these payments?

If not, the car could be taken away and your credit score would fall making it harder, or more expensive, to borrow in the future.

Checking your credit score

You can check your credit score for free at each of the three main credit reference agencies in the UK: Experian, Equifax and TransUnion. You’ll see a number and an explanation.

If you spot anything that isn’t right, contact the agency as soon as possible as any missing or wrong information can have a negative impact on your score.

Determining your budget

You need to determine your budget and make sure all the costs involved in in the car finance deal you have chosen fall within that budget

Most car finance deals require a non-refundable deposit when you start the contract. You will then make monthly payments, for the term of the contract, and may have the option of paying for a maintenance package.

A few other things to watch out for include early repayment fees and fees if you break a condition of the contract – such as if you exceed the agreed mileage. Depending on the type of agreement, you may also need to budget for a final payment if you would like to keep the car.

Choosing the right finance option

Choosing the right finance option will depend on your personal circumstances.

• If you’d like low monthly payments and the option of buying at the end of the contract or returning the car, PCP might work for you.
• If you would like to own your car, but can’t afford to buy it outright, check if an HP deal suits.
• If you have a good credit score and would like to own your car outright, compare car finance options with a personal loan.

Understanding the terms and conditions

Check the terms and conditions and make sure you understand the small print as this is where you will find the information on any extra fees. It will also give you details about what could happen if you miss a payment or you’re late making it.

As you are taking out a financial product, you should also check that the car finance provider is registered with the Financial Conduct Authority (FCA).

Considering the total cost of ownership

When calculating your budget for a vehicle, you will need to consider the total cost of ownership, which could include the following:

• Initial deposit
• Interest payments (shown as the APR)
• Final lump sum
• MOT
• Road tax
• Fuel costs
• Car insurance
• Parking fees
• Breakdown cover

Planning for depreciation

Depreciation is the rate at which a car loses its value and you need to plan for this. A new car loses value the moment you drive it away from the dealership. With car finance agreements where there is an option to return the car, such as with PCP, depreciation is taken into account when calculating how much you will pay each month.

Lenders use the GMFV (guaranteed minimum future value) – the amount they think the car will be worth at the end of the contract – to work out how much a person will pay monthly, and for an optional final payment.

If you choose a vehicle that has a high rate of depreciation, your monthly payments will usually be higher.

Commonly asked questions

Is it best to finance a car through a bank or a car dealership?

If you choose a bank for your car finance, you will own the car straight away and repay the bank. If you use dealership financing, you can choose a car finance offer, such as PCP, where you have the option of returning the vehicle at the end of the agreement or paying a final sum to keep it.

There are pros and cons to each option.

What option should I choose if I have a bad credit score?

Your options may be limited if you have a bad credit score as fewer firms will lend to you. You may also be charged a more expensive interest rate than someone with a good credit score. This is because a lender will see a higher risk of the loan not being paid back by you.

It might be better to wait and improve your credit score before applying, so you can access a cheaper contract. If waiting is not an option, make sure you’re comparing all of the costs and you understand all of the potential fees.

How will car finance affect my credit score?

Your car finance deal will, like all credit, be added to your credit file. A credit file is a tool used by lenders to see if people make payments on the credit they have already taken out. If you make repayments on time, this should help improve your credit score. However, if you miss any payments, are late or fail to pay, this will damage your credit score, and may make it more difficult to obtain credit in the future.

Even just applying for car finance will prompt a hard credit search and a mark will be left on your credit history, whether you are accepted or not.

What happens if I crash my car on finance?

If you crash a car you have on a finance deal, your car insurance should cover the costs to repair or replace the vehicle if you have comprehensive insurance.

If your car is a write-off, your insurer will give you the value of the car at that time. But your insurer is likely to pay a value that is less than the total you still owe on finance.

You may have two choices:

• Use the insurance money to replace the vehicle and continue making payments to your car finance provider
• Use the insurance money to repay as much of the car finance deal as possible and reduce your payments – or clear them

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Who takes care of maintenance of the car on finance?

Unless maintenance costs are included in your car finance agreement, you are responsible for maintaining the car you’re driving.

Can I pay off my car finance early?

You may be able to pay off a car finance loan early, but there may be early settlement fees. The amount will depend on the loan, but it can be between one and two months’ interest.

Can I overpay my monthly payments?

If you are able to pay more towards your car loan, such as if you receive a bonus at work, you may be able to make an extra payment. However, as with ending a contract early, there may be fees to pay. Read the small print or ask before signing your deal.

Is insurance included with car finance?

Car insurance is not included with a car finance agreement, although car dealers often throw in extra perks and it may be one of them. There are lots of insurers around and the price you pay will depend on lots of different factors, so comparing costs, cover levels and policy wordings is the best way to quickly find the best policy.

Summary and conclusion

Buying a car on finance is a popular way to get a new or second-hand vehicle. The Finance and Leasing Association reported that more than 640,000 new cars and nearly 1.5 million used cars were bought on finance in 2023.

There are lots of choices available and it’s especially useful if you aren’t able to pay for a car outright, or you know you’d like to change the car in a few years.

However, as with any finance agreement, it’s important to calculate all the costs and to watch out for any hidden fees. You will need to think carefully about the type of agreement that suits you best. There are plenty to choose from, and they all work a little differently, giving you the flexibility to choose a deal that works with your budget.