Types of Car Finance in the UK

By Leanne Winters - Published: 18 November 2022

Most people in the UK can’t afford to pay for a brand new car with one lump sum.

Many people find themselves in need of a new car without the funds that they need to pay for it outright.

Car finance allows you to spread the cost of a new car over a number of months or years.

However, there are disadvantages to this, and it’s always best to do your homework so you can find the best offer for your needs and budget.

In this guide, we discuss the pros and cons of each type of car finance in the UK.

How does car finance work?

Car finance comes in a range of forms. These include personal loans, lease purchase, contract purchase (PCP) and hire purchase (HP) alongside other options.

The payments that you’ll need to make during the period can depend on a range of factors. These include the amount you need to borrow, how long you want to keep the vehicle for and what type of agreement you opt for.

WARNING – OUTSTANDING FINANCE – if you’re considering buying a used car, it may have outstanding finance that could make you pay double the amount, check it first for Outstanding Car Finance.

What different kinds of car finance are available?

Here are some of the main forms of car finance.

Personal Loan

If you do want to buy a car outright, one step that you could take is to apply for a personal loan to cover the cost.

You’ll need to repay the loan over a set period of time, and this will normally be at a fixed interest rate. A big advantage of using a personal loan is that it is unsecured.

This means you won’t need to use an asset like your house or car as security. If you do have to use something as an asset, the lender will be able to forcibly sell it if you can’t repay the loan. You may need a good credit score if you want an unsecured loan as this means more risk for the lender.

You may find it easier to get approval or a better interest rate if you apply for a loan that’s secured against your car. Just remember that you could lose your car if you’re unable to keep up with the repayments.

Advantages of a personal loan

As the finance will have already been agreed upon, this could make it easier for you to negotiate the price of your car
The loan won’t be secured against the car, which means it can’t be repossessed
You can sell the car at any point during the agreement – just keep up with the repayments
The payments will stay the same for the whole term – this makes it easier to budget
You can buy a car from anyone if it’s been funded by a personal loan

Disadvantages of a personal loan

You’re less likely to be accepted for a personal loan if you have a poor credit history
You can’t normally get a personal loan for more than £25,000
The checks carried out on sellers during PCP and hire purchase applications won’t be made if you fund your car with a personal loan

Hire Purchase

If you enter into a car hire purchase agreement, you’ll normally need to make a deposit to gain access to the car.

Following this, you’ll need to make monthly payments towards the car. However, the car won’t be yours until you have made the final payment.

This means you can’t sell it during the agreement. You could hand back the car at the end of the agreement, or pay the ‘option to purchase’ fee at the end. Your debt will be secured against the car, which means you could lose the car if you stop making the payments.

You may also need to pay a penalty fee if you end the agreement early.

Advantages of hire purchase

You won’t have mileage restrictions imposed on you
You won’t need to pay a hefty lump sum at the end of the agreement
Your payments will be fixed over the entire period which makes it easier to budget
Your lender will normally carry out checks on the dealership to protect you before you enter into the agreement
Once you have repaid half of the total repayable amount, you can opt for Voluntary Termination (VT), which means you can hand the car back if required
The finance is agreed upon upfront, which means you can negotiate the price of the car

Disadvantages of hire purchase

The monthly payments tend to be higher than your other options
Your loan will be secured against your car, which means it could be repossessed if you don’t make the monthly repayments
Conditional sale agreements
Conditional sale agreements are similar to Hire Purchase agreements, only you will own your car automatically once you have repaid the finance. Some conditional sales agreements include balloon payments at the end of the agreement.

0% Finance

In a 0% finance agreement, you will need to pay a large deposit. You may also find that your monthly repayments are rather high.

However, you shouldn’t need to pay any interest on your debt as long as you comply with the terms of the agreement and all your payments are made on time and in full.

Leasing

With car leasing, you don’t get to own the vehicle.

You just pay to use it. The cost you’ll be charged will depend on factors like how much the car is worth, how long you need it for and your mileage allowance. You could be charged an ‘excessive wear and tear’ fee if the car isn’t in great condition when you hand it back.

You will normally need to take out fully comprehensive car insurance, and you may also be required to take out gap insurance so the lender has extra protection from damage and theft.

Personal Contract Purchase (PCP)

PCP loans are very popular, though they can seem complex to some.

You won’t be purchasing the car outright, but you will put down a non-refundable deposit towards the cost of the vehicle and borrow the rest.

The monthly payments that you make will cover not only interest but the cost of depreciation, which is how much value the car loses whilst it's in your possession.

At the end of the contract, you can:

Purchase the vehicle outright. Pay the value of the vehicle minus the cost of your deposit. The value is normally agreed upon when your contract begins. You may need to pay an additional fee.
Trade it in for a replacement and start a new PCP contract
Return the vehicle. As long as you have complied with the terms and there is no damage, you shouldn’t have more to pay.

These loans are often used by those who change their vehicle on a regular basis. They have the benefit of being rather flexible and usually involve low monthly payments due to the fact you won’t be paying the car off.

However, you can expect to be met with high interest rates. Read the agreement carefully before you sign in and look out for penalty charges as you could be charged for damage and exceeding your mileage allowance.

If you want to get approved for this kind of agreement, you will normally need a good credit history. This is incredibly likely to be the case if you’re interested in a low APR or 0% interest deal.

Advantages of a PCP

Keep the car or hand it back when the contract ends
Monthly payments generally affordable due to the lump sum you’ll pay at the end
Fixed cost over a set period secured against the purchase so you can budget more easily
May be able to negotiate a better price for the vehicle as the finance will be agreed upfront

Disadvantages of a PCP

If you want to hand back the car at the end of the agreement, you may be charged if it’s not in the condition it was at the start, or if you have exceeded your mileage allowance
If you want to keep the car, you’ll need to make the balloon payment. This will be linked to the estimated value of the car at the end of the agreement when you first sign it
You’ll need to pay interest on the balloon payment during the agreement. This won’t be refunded if you decide not to keep the vehicle.

0% purchase credit card

Another option is to purchase your car with a 0% purchase credit card.

More and more dealers are now accepting credit cards. If you want a high limit on a purchase card, you’ll normally need to have a good credit score.

A credit card can give you more flexibility. You are free to decide how much you want to pay off each month as long as the minimum repayment is et. If you have a 0% purchase card, you won’t have to pay interest on the purchase you’re making for a set length of time.

You just have to remember to make the minimum monthly repayments on time and in full to keep taking advantage of the promotional rate. Try to pay the debt off before the end of the promotional period so you can avoid paying interest at the standard rate.

Part-exchanging

The part-exchange option could be for you if you don’t want to make a cash deposit.

You could part-exchange your existing card towards the deposit, or you may be able to part-ex the car as part of the whole transaction.

Part-exchanging will also allow you to get rid of a car you no longer want or need and can reduce the amount of time it takes to offload it. If you don’t have a cash deposit or a car, no-deposit finance could be a good option for you.

Am I likely to be accepted for car finance?

You are more likely to be accepted for car finance and get a good rate if you have a good credit score.

Your credit score is worked out using information that’s on your credit report as well as details you have given as part of your application like your income. If you are an existing customer, the lender may also use the information they already have about you.

Can younger drivers get car finance?

Young drivers often have little to no credit history.

This can make it tough for the lender to judge how able you’ll be to make repayments. However, you can take steps to build your credit score to make it easier to get finance.

Another option that some young drivers have is to apply for a guarantor loan. If you do want to do this, you’ll need to ask someone if they’ll agree to make the repayments for you if you cannot.

What should I consider before I apply?

Before you apply for finance to fund a car, you’ll need to consider several things. These include:

The amount you need to borrow
How much you can afford to pay every month
The kind of rate you’ll get and whether a variable rate might be affordable
How long you want to repay the loan for
Whether you want to own the car
How long you’ll need the car for
How much you want to pay in interest
Whether you’ll be happy with a mileage limit
How many miles you’ll be driving
Whether you’re happy to pay additional fees

Don’t forget that driving a car involves additional costs like insurance, repairs, fuel, road tax and MOTs. Make sure you can afford these costs as well as the monthly payments.

You’ll also have to think about any other financial commitments that you might have. If you ever miss a repayment, your credit score could be impacted substantially, and you may find it more difficult to obtain credit in the future.

Managing your repayments

Once you have entered into your agreements, you’ll need to manage them effectively so your credit score is protected.

Stick to the monthly repayments and always pay in full on time to protect your score and avoid additional charges.

At the start of the month, budget carefully so you know you’ll have enough cash for the repayments. If you’re worried you might forget to make a payment, you could set up a direct debit so the funds come out of your account automatically.

Avoid taking out more credit whilst you are repaying the loan if you can to protect your score and maintain good financial health.

Conclusion

We hope you enjoyed our article on the types of car finance in the UK.

If you have any questions, then leave them in the comments, or email us at sales@carregchecks.co.uk.