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What car financing options are there?
Unless you’ve got a huge reserve of savings, it’s likely you’ll need to consider car financing options if you need a new set of wheels, but which deal is the right one for you? We explore a range of options and weigh up their pros and cons so that you can make an informed decision.
What are the different types of car financing?
If you need a new car, the good news is that there’s a range of financing options. The downside is that some share similarities which can make it tricky to choose between them, but here’s what to consider:
Personal loan
Also known as an unsecured loan, you can take out a personal loan to cover the cost of buying a car outright. You’ll then pay back what you owe each month over a fixed period of time, plus interest.
As personal loans are not secured, you’re not borrowing the money against any of your assets. This increases the risk for the lender because if you stop paying back what you owe (default) it’s harder for them to recoup the money they’ve loaned to you. The flip side is that a personal loan is less of a risk for you as none of your assets are at stake (like your home, for example).
The benefit of a personal loan is that depending on the interest rate you pay, it could work out more economical than a financing option offered by a car dealership. The downside is that you’ll usually need a good credit history to be eligible for a personal loan and also to get the most competitive interest rates.
Credit card
Depending on your credit limit and the cost of the car, using your credit card may be an option.
Using a credit card gives you a much greater level of flexibility compared to other methods of financing. This is because you can choose how to pay it off, for example, you may be able to pay off half in one go then spread the rest over a few months.
If you’ve got a 0% interest credit card, you’ll also avoid added interest charges. Just remember to meet your minimum monthly payments, otherwise you’ll end up paying late fees; consistently missing payments can also hurt your credit rating in the long term.
One of the drawbacks is that you’ll usually need a good credit history in order to have a credit card with a high enough limit to buy a car. In other words, it’s not always a readily available option.
Hire purchase
Most of us will be familiar with hire purchase (HP). It’s typically offered on all sorts of bigger-ticket items such as electrical goods and furniture as well as cars.
In most cases, you’ll need to pay a deposit to secure the car, you’ll then pay the remaining amount (plus any interest) in monthly instalments over a fixed period of time. Technically, you won’t actually own the car until you’ve made the final payment, which means you won’t be able to sell it before then.
HP plans are usually straightforward with a clear payment plan that will enable you to own the car by the end of it. As ownership is the end goal, you won’t need to worry about returning the car in a specific condition (unlike some other options which we look at below).
One of the downsides to HP is that the car will be used to secure the loan, so if you miss payments, the car could be taken away. You’ll still be expected to cover any outstanding costs should that happen.
Personal contract purchase (PCP)
With a PCP plan, you’ll need to pay a deposit and then pay monthly instalments for an agreed period of time (typically three years).
At the end of that period, you’ll have three options:
- Return the car to the dealership – the expectation is that the car will still be in good condition and will only have covered a certain number of miles (this is something you’ll usually agree when you take out the contract).
- Buy the car outright with a final payment – this amount will have been pre-agreed between you and the dealership. The final lump sum payment is also known as a balloon payment.
- Switch to another PCP plan – your dealership may offer you another PCP plan on a new car, using the value of your current model as a deposit. It’s similar to if you were part exchanging your old car for a new one. If you choose this, you’ll agree another PCP plan with the same or similar options at the end of the agreed period.
Unlike HP, the aim of PCP isn’t necessarily to own the car and people often simply return it, leaving them free to look for other deals elsewhere. The benefit of this is that you could in theory, drive away in a new car every few years.
However, because of this, dealerships will have certain expectations about the condition in which the car should be in and its mileage. If you want to return the car and there’s any damage (that isn’t considered normal wear and tear) or you’ve covered more miles than agreed, you’ll have to pay additional fees.
PCP plans can also feel very complicated because of the way contracts and payments are calculated. Fundamentally, with a PCP plan, you’re not actually paying off the cost of the car (as you would be with HP). You’re actually covering the cost of depreciation (the amount of value the car will lose over time). That said, PCP is one of the most common options available and around 80% of brand-new cars are financed this way.
Personal contract hire (car leasing)
Car leasing is exactly as it sounds, so you’ll never own the car. The easiest way to think of it, is that it’s essentially a long-term hire agreement. As with other financing options, you’ll pay a deposit and then make regular payments over an agreed period of time.
At the end of that fixed period, you’ll hand the car back to the dealership. Like PCP plans, car leasing is an option that means you can drive a new car every few years.
The flip side is that the dealership will have certain expectations about mileage and the condition of the car when you return it (similar to PCP plans). If there is any damage beyond wear and tear or you’ve exceeded the agreed mileage, you’ll usually have to pay additional fees.
What’s the best car financing option?
Each option comes with its own pros and cons, and it will depend on what your long term aim is. For example, if the aim is to eventually own the car outright, the simplest options are buying the car through hire purchase, credit card or personal loan.
PCP plans do give you the option of buying the car, but you’ll need to cover the final balloon payment. Depending on the vehicle you have, this can still be a hefty amount of money.
If you like the idea of upgrading to a new car every few years, then PCP or car leasing plans are more suitable options.
Before you start your search for a new car and discuss financing options, consider:
- What your goal is – think about whether you want to own the car or not as this will help narrow your choices.
- Interest rates – specifically, look at the APR as this takes into account all the fees you’ll be charged for borrowing money. Comparing the APR offered on all options will give you a clearer idea of what deal offers better value. The higher the APR, the more you’ll end up paying overall.
- Any conditions and limitations – PCP and car leasing deals come with lots of conditions about the state of the car on its return. Be aware of what those conditions are and the penalties for breaking them.
- Changing circumstances – some deals (like PCP and car leasing) are a commitment, and plans can run for up to four years. While there is likely to be some flexibility if your circumstances change, you’ll need to be fairly confident about being able to make your monthly payments for the entire length of the contract.
- Extras and maintenance – dealerships often incentivise drivers, especially when it comes to PCP and car leasing plans. This could mean you’re offered heavy discounts on servicing if you buy into certain packages.
You shouldn’t ever enter a credit agreement that you don’t fully understand so don’t be afraid to ask the dealership to explain what various terms mean. Most reputable dealers will never pressure you into making a decision, so don’t feel you need to rush into signing a contract.
As well as making sure you get a good deal on your car financing, remember to shop around and compare car insurance too. To help you get great value, here are some handy tips and advice: