How to buy a car on finance

Oct 17, 2014

Hire purchase, bank loans, personal contract purchase or lease? Carbuyer tells you all you need to know.

Think you can’t afford a new car? Think again. Today, around eight out of every ten cars bought privately are purchased using some sort of loan or finance. And even though they can be cheaper, used cars are also very commonly bought using finance.

There are many different types of finance available, each with their pros and cons, so it's important to work out which is right for you.

Cash or credit cards

The most straightforward way to pay is in cash – or at least with a cheque or debit card. But when even the cheapest new cars cost several thousand pounds, few of us are willing – or able – to pay in one go.

Credit cards are another option, but unless you’re able to transfer the balance from one card to another, or are in a position to pay off the balance quickly, the interest will be prohibitively high. We wouldn’t recommend it.

Also bear in mind that dealers get commission from lenders in return for signing you up for car finance deals. They can then use some of this commission to fund discounts for you, so if you pay cash or use a credit card, there could be less room to haggle.

Personal loans

A personal loan is when you borrow money from a high-street bank, online lender or the Post Office and repay it each month over an agreed period of time at a set interest rate.

There are two types: secured and unsecured. A secured loan requires some form of collateral (usually your house) that the lender will take and sell to recover its cash if you fail to pay them back. An unsecured loan doesn’t require collateral – instead, the lender decides whether it can trust you to repay the money based on your credit rating.

When taking out a personal loan – or any of the other forms of borrowing mentioned in this article – be sure to check the Annual Percentage Rate (APR), which tells you how much the loan will cost you per year. The figure includes the interest rate plus any fees. The lower the percentage, the less you’ll have to pay back.

There are two main advantages to a personal loan. The first is that you don’t have to put down a deposit, which you almost certainly will do with the other forms of finance. The second is that you will own the car outright and won’t face any restrictions as to how you drive it – which isn’t the case with dealer finance or lease deals.

The disadvantage of a personal loan is that the monthly payments and APR are likely to be higher than for dealer finance.

Logbook loans

Logbook loans are a fairly recent development. This is a loan secured on your car, but their nature means you can’t use them to fund a car to directly replace the one you’re borrowing against.

They’re fairly quick to arrange, either online or on the high street, and usually allow you to borrow between £500 and £50,000 depending on the value of your car. In most cases, you can borrow up to 50% of its value.

The agreement involves handing over your vehicle's V5C document (also called the logbook). This means the lender will temporarily own your vehicle until the loan is settled.

APR for logbook loans can be extremely high – around 400% in some cases – and most logbook loans run for 78 weeks (18 months). Interest is charged on the loan amount each week, meaning a £1,500 loan could cost £2,750 in interest alone.

Because the loan is secured on your vehicle, failure to repay means the lender could seize your car.

Dealer finance

Hire Purchase

Hire purchase (HP) is a quick and easy way of borrowing money to buy a car. It's usually arranged by the dealer, which takes all the legwork out of applying for a loan.

It's a simple set-up, too. You pay a deposit – usually around 10% of the total price – and then monthly instalments for the duration of the contract. You can reduce your monthly repayments by increasing your deposit or extending the duration of the loan. As with all forms of borrowing, it's important to check the APR, as that shows how much the loan will cost you. And remember, the longer the loan runs for, the more interest you’ll pay.

The advantages of HP are that it's quick and easy to set up and will be available to most customers – even those with poor credit ratings – because the car is used as collateral. The monthly payments will be lower than for a personal loan, and there's no lump sum to pay at the end.

There are two disadvantages with HP. The first is that you’ll have to pay a deposit up front out of your own pocket – and this can run to several thousand pounds. The second is that the car is owned by the finance company until you make the final payment. And if you fail to make a payment, it can repossess the car.

That means that if you sell the car before the end of the loan period, you must notify the buyer and pay off the loan – otherwise the lender could seize the vehicle from the new owner.

Personal contract purchase

Personal contract purchase (PCP) is similar to HP. It's also arranged through the dealer, so it's easy and quick. Most car manufacturers have their own schemes, each with its own name, such as Ford Options, BMW Select, MINI Select, Volkswagen Solutions and Volvo Advantage.

You pay a deposit and monthly payments over an agreed term, but a big chunk of the car's value is left until the end of the contract in the form of an optional final payment (often called Guaranteed Minimum Future Value, or GMFV).

When your contract is up, you can either pay the lump sum to take ownership of the car, or simply hand it back without paying the final fee. Alternatively, you can use any difference between the GMFV and the actual trade-in value of the car at the end of the agreement as part or all of a deposit on a new model.

The advantages of PCP are that the deposit and monthly repayments are usually a lot lower than for HP, because of the large lump sum at the end. It's also easy to obtain, because (as with HP) the car is used as collateral and remains the property of the finance company until the final payment is made. And because manufacturers are keen to push PCP deals, they often offer very low interest rates – 0% APR deals are common.

There are two main disadvantages of PCP. First, if you can’t afford the final payment at the end of the contract, you won’t be able to take ownership of the car. Secondly, manufacturers usually set limits on how many miles you can drive the car per year – and if you go over the agreed amount, they’ll charge you for every extra mile. Plus, you’ll need to ensure the car is returned in good condition and maintained in accordance with the manufacturer's service schedule.

Leasing deals and contract hire

It is possible to lease a car for an agreed amount of time. Some manufacturers offer leasing deals directly through their finance companies and there are also plenty of internet-based companies that specialise in leasing cars.

As with HP, you’ll pay a deposit and monthly payments for the term of the contract. But unlike HP or PCP, you’ll never be able to own the car – this is strictly a rental agreement.

The main advantage of a lease deal is that the deposit and monthly payments are even smaller than for PCP – so you can drive a car you wouldn’t be able to afford if you were looking to buy. Servicing is often included in the cost, too.

The biggest disadvantage is that you’ll never own the car, despite paying a considerable sum of money for it. And, as with PCP, the finance company will impose restrictions on how many miles you can drive, with charges for every mile you do over the limit.

Car finance terms explained

APR (Annual Percentage Rate) APR gives you a realistic idea of the total cost of your borrowing. A basic flat rate of interest can be misleading, as it doesn’t include any extra costs or fees.

Deposit contribution Some manufacturers will make a contribution towards the deposit on a new car as an incentive to purchase. The value of this contribution can vary from a few hundred to several thousand pounds. These contributions are usually available for fixed periods of time, and you may have to sign up to certain finance packages to take advantage of then.

Excess mileage When leasing or buying a car on a PCP, you may be restricted to covering a certain mileage, which helps predict the future value of the car. This can usually be negotiated when you sign up, but it's worth erring on the side of caution, because you could be charged several pence per mile if you go over the limit.

Gap insurance This is a finance product that covers the shortfall between what your insurance company will pay if your car is written off or stolen and what you originally paid for the car. You can pay monthly or up-front, and it's available for new and used cars bought on finance.

Guaranteed Minimum Future Value (GMFV) When buy a car on PCP, the dealer will give you a guaranteed minimum future valuation so you know how much it’ll be worth at the end of the agreement. This means you’re protected from any sudden and unexpected drops in value. It also means you know how much you’ll need to pay to settle the PCP agreement, or how much your car will be worth if you hand it back in settlement. The GMFV is usually a conservative estimate of how much the car will be worth at the end of the agreement, so if it ends up being worth slightly more, you can use the equity as part of the deposit on your next car.

Zero percent or 0% APR The holy grail of interest rates. This means that what you borrow is the same as the amount you pay back. Borrow £10,000 at 10% APR and you’ll pay back £11,616 over three years, but at 0% APR, you’ll only pay back the £10,000 you borrowed.

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