How to buy a car on finance

Oct 16, 2013

Hire purchase, bank loans, personal contract purchase or lease? CarBuyer investigates

There was a time when the only way to buy a car was to pay the whole amount up front. But these days, three quarters of all new cars are bought through various forms of loans – and an increasing number of second-hand cars are bought with borrowed money, too. But what are the different loans available, and what are their advantages and disadvantages?

For the purpose of this article, we’re going to divide the various forms of loans into three categories: personal loans, dealer finance, and leasing deals. 

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 judges from your credit rating that it can trust you to repay the money.

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 better.

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 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 through dealer finance.

Dealer finance

Hire Purchase

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

It's a simple set-up, too. You’ll pay a deposit – usually around 10 per cent of the total price – and then monthly instalments for the duration of the contract. As with all forms of borrowing, it's important to check the APR, as that shows how much the loan will cost you.

The advantage of HP is that it is quick and easy to set up and it will be available to most customers – even those with low credit ratings – because the car is used as collateral. The monthly payments will be lower than with a personal loan, and there won’t be a lump sum at the end like with a personal contract purchase deal (see below).

There are two disadvantages with HP. The first is that you will have to pay a deposit up front out of your own pocket – and this can run to many thousands of 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.

Personal contract purchase

Personal contract purchase (PCP) is similar to HP. It is also arranged through the dealer, so it's easy and quick. You pay a deposit and monthly payments over an agreed contract, but a big chunk of the car's value is left until the end of the contract as an optional final payment (often called Guaranteed Minimum Future Value or GMFV).

When your contract is up, you can pay the outstanding lump sum to take ownership of the car, you can hand the car back without paying the final fee, or you can trade the car in using the leftover value as part or all of a deposit on a new model.

The advantages of PCP deals is that the deposit and monthly repayments are usually a lot lower than in HP deals because a big lump of the repayment is left until the end. It's also easy to get because, just like with HP, the car is used as collateral and is owned by the finance company until the final payment is made. And because manufacturers are keen to offer PCP deals, they often offer very low interest rates – 0% APR deals are common.

The are two main disadvantages. Firstly, 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 will charge you for every extra mile.

Leasing deals

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 firms that specialise in leasing cars.

Like with HP, you’ll pay a deposit and monthly payments for the term of the contract. But unlike HP and PCP you will never get the opportunity to own the car – this is strictly a rental agreement.

The advantages of a lease deal is that the deposits and monthly payments are even smaller than on PCP deals – so you can get behind the wheel of a car you wouldn’t be able to afford if you were looking to buy. And servicing costs are often take care of, too, as part of the lease.

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

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