Car Finance Explained: Your Car Finance Options
Taking the mystery out of your car buying journey.
Car Finance Explained: Your Car Finance
Taking the mystery out of your car buying journey
Buying a car is an exciting experience. It’s also one of the biggest purchases you’ll make. It’s important to understand all of your options, especially when it comes to the question of how you’ll pay for your car.
If you’re thinking of using finance to buy your next car, you may be feeling confused by all the car finance options available. With so many products on the market, and lots of confusing jargon, taking out a car loan can become a minefield.
Our ‘Car Finance Explained’ guide is designed to take the mystery out of it all so that you can focus on enjoying your car buying journey!
How does financing a car work?
For most people, buying a car outright isn’t possible. For this reason, more and more people are opting to finance the car of their dreams.
Car finance allows you to drive a car without having to pay a lump sum upfront for the car. You make affordable monthly payments directly to the lender. The lender owns the car until you have paid the borrowed amount (plus interest and any charges) in full. Whilst you are paying for the car, you have full use of it – as though it is yours.
The amount you pay each month, the interest rate, the terms of the agreement, and your options at the end of the agreement, will all vary depending on which finance option you go for. Below we go into more detail about your car finance options.
What are my car finance options?
It is important that you understand the difference between your car finance options. Not all options are suitable for everyone, and your circumstances may dictate the best option for you. Below are the most common types of car finance:
How does Hire Purchase work?
Hire Purchase, or HP, is considered the simplest type of car finance – which is why it’s so popular. It allows you to spread the cost of the car, plus interest, across a set period of time.
With Hire Purchase, a deposit is not always necessary. However, it is worth bearing in mind that a deposit will bring down the balance, limiting the amount of interest incurred and reducing the monthly payments. Many people trade in their old car to provide a deposit.
The lender simply takes the price of the car (minus any deposit) and adds interest. The final figure is then divided over the term agreed, usually between two and five years.
The monthly payments never change throughout the agreement, allowing you to budget for your outgoings. There is no large final payment at the end, although there is usually admin and transfer of rights fees to pay. Once you’ve paid the agreement off in full, the car belongs to you.
Hire Purchase pros and cons
What is Conditional Sale?
Conditional Sale is similar to Hire Purchase, accept that you pay higher monthly payments and don’t have a fee at the end. As soon as you’ve made the final payment, the vehicle becomes yours.
Conditional Sale pros and cons
What is Personal Contract Purchase (PCP)?
Personal Contract Purchase has gained popularity because the monthly payments are lower compared to HP, allowing you to buy a newer or higher spec of car. However, this type of agreement is also a little more complicated than Hire Purchase.
With a PCP agreement, your monthly repayments are lower because a significant proportion of the borrowing is deferred to an ‘optional final payment’ at the end of the agreement. This final payment is often called a ‘balloon payment’.
You’ll need to decide how much deposit you want to make. You’ll also need to estimate your expected annual mileage and decide how long you want the agreement to run for – normally between two and four years.
Guaranteed Future Value (GFV) explained
The lender will use this information to calculate the Guaranteed Future Value of the car, or the GFV. The GFV is a forecast of what the car will be worth at the end of the agreement, based on your initial estimate of your annual mileage. This value forms the ‘deferred final payment’ and is guaranteed by the lender.
To work out your monthly payments, your initial deposit and the optional final payment are deducted from the price of the car. The amount left over, plus interest, is then divided over the term and forms the fixed, monthly payments.
You must be realistic about your expected mileage as excess mileage charges are expensive. You’ll also be expected to return the car in good condition. Any damage that is not classed as ‘fair wear and tear’ will also be subject to charges. Your contract will detail the terms and conditions of the agreement and so it is important to read your paperwork thoroughly before signing on the dotted line.
At the end of the agreement, you will have three options.
You can part-exchange the car for a newer model. If, at the end of the agreement, the car is worth more than the optional final payment, you can use this equity as a deposit towards your next car.
PCP finance pros and cons
How do Personal Car Loans work?
With a personal car loan, or unsecured loan, you borrow the full amount and buy your car outright. If you have a good credit profile, you will be able to access the best interest rates, which could be cheaper than other car finance options. Since the car belongs to you from the beginning of the agreement, you can choose to sell the car at any time.
Pros and cons of taking out a personal loan
What is Guarantor Car Finance?
A guarantor loan for car finance can be an option where you have bad credit. Guarantor car finance involves a third party agreeing to pay your loan if you can’t make the repayments.
A guarantor loan can provide the opportunity not only to drive a car, but also build up your credit profile. However, it is also a big responsibility since your guarantor is liable for your finance if you do not repay it. You can read more about Guarantor Car Finance here.
Guarantor Loan pros and cons
What is Personal Contract Hire (Leasing)?
Personal Contract Hire or Leasing basically means that you rent the vehicle for a set period of time. Personal Contract Hire is great if you like changing your car often but wish to avoid the associated costs, such as depreciation.
At the start, you will need to decide on your expected annual mileage and lease period. The higher your annual mileage, the higher your monthly payment since the car will be worth less once you hand it back.
You will normally need to pay a deposit upfront, and then monthly payments to lease the car. At the end of the agreement, you will need to hand the car back, and there is no option to buy the car. The car must be returned in an acceptable condition that meets ‘fair wear and tear’ guidelines. Where damage is excessive, charges will apply for the repairs.
Car leasing pros and cons
Car Finance Jargon Buster
The car finance industry is full of unusual terminology, which can make applying for car finance even more daunting. Our jargon buster helps shed light on some of the most common car finance terminology.
Frequently Asked Questions
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