Ideally, you would be able to pay for your car up front. One simple payment of the price of the car with no need to work out the best finance options, repayment plans or interest rates. This isn’t a realistic option for everyone though, so you might be looking for alternatives.
Below are the most common financing options, terms you should know as well as some advice on how to keep your costs down.
What are my options?
We can split your financing choices into two groups
- Independent loans – borrow money from a lender, normally a bank, pay for the car and pay back the loan.
- Dealer agreements – work out an arrangement with the seller, normally hiring the car and paying off the cost
1. Independent loans
You borrow the money you need to buy the car outright and arrange a repayment schedule with the lender, normally a high street bank. You can choose to secure your loan against an asset, usually your house or, if you don’t want to risk losing your possessions, you can choose an unsecured loan and any late or missed payments will incur a late fee.
- Easy to organise – you can organise your loan easily on line or in almost any branch of a bank.
- Fixed repayments – you will arrange the length of your loan and your monthly repayments when you apply, so it is easy to budget.
- Early settlement charge – you may have to pay more if you decide to pay off your loan early.
- Higher APR – your repayments may well be higher than if you used some dealer finance options
- Delay in receiving your money – lenders can take time putting the money into your account
You can take a loan out to cover the entire cost of the car, but you don’t need to. This type of agreement is run separately from the dealer, so you can borrow as little or as much as you need.
2. Dealer agreements
Personal hire purchase (PHP)
Hire purchase allows you to lease the car and pay for your car in instalments over 1-5 years. You will usually need to put down a deposit but you can drive away in your new car. The loan is secured against the car so it isn’t technically yours until the last payment is made.
- Quick and easy to arrange – this is a contract with the dealer so you can arrange your hire purchase when you buy the car
- Flexible repayments (1-5 years) – the monthly instalments will be affected by the length of the agreement
- Low deposit – you can normally pay as little as 10% up front but this will vary from dealer to dealer
- Fixed interest rates – the interest rate is agreed at the start so you know how much each payment will be for the length of the term
- You don’t own the car until the final payment – the car is not actually yours, you are only leasing it until you have paid off your loan.
Your monthly payments will be higher the shorter the term and the smaller your deposit so make sure you agree a schedule that you can afford. Be aware that until you have paid off a third of the total amount, the dealer can repossess your car without a court order. This is unlikely to happen but be sure to note the date in your agreement.
The APR on hire purchase is normally very competitive for new cars but can be more expensive on second hand models. Make sure you shop around before committing to the dealer.
You may also be offered a Balloon Hire Purchase. You pay a deposit at the start of the agreement as well as a ‘balloon’ payment at the end that are deducted from your payments across the length of the agreement.
Personal leasing/Personal car Hire (PCH)
Many dealers will actually lease or hire cars rather than selling them. At the end of the term you just return the car to the dealer and trade for a new one. The cost will be the same as the depreciation of the car over the term of your lease.
- Flexible payment terms – you can choose the length of the lease
- Free servicing – most lease agreements will include free servicing
- Large deposit – you will have to pay a deposit, normally about 3 months rental
- Driving limitations – most lease agreements will come with restrictions on how far you can drive your car each month - If you exceed this amount you may have to pay extra or even lose the car
- You never own the car – this is simply a long term hire car. You are not actually buying your car so you can’t modify or sell it
The balloon payment system works for personal leasing agreements. At the end of your lease you may be able to pay off the remaining value of the car and own the vehicle outright.
What should I look out for?
As you compare car financing there are a few key things to do before you make your decision:
- Make sure you can afford the payments – no matter what financing scheme you use, if you start missing payments you will either have to pay the fees or worse, lose your car
- Compare total cost of borrowing – small monthly payments may seem attractive but they can quickly add up. Make sure you know the total costs over the term.
- Look out for other charges – there can be lots of extra charges within any loan or hire. Make sure you read the small print and factor in the hidden costs
- Shop around – make sure you find the right deal for you. There are so many lenders and dealers that you can afford to shop around.
What are interest rates?
The interest rate is the cost of borrowing money. The actual rate will differ from each loan and lender. For example, if you took a loan of £2000 for the period of one year and the interest rate was 5%, you would pay £100 on the interest rate. This is because you are paying back 5% (£100) on top the loaned amount, £2000.
What is APR and how is it calculated?
APR stands for Annual Percentage Rate of charge. The APR is calculated by taking into account the overall cost of everything, this includes the interest rates and the agreed upfront costs. Legally the lender has to tell you the APR before you sign for the loan.
What is a deposit?
A deposit is an upfront payment you have when you sign a finance deal with a dealer. The size of the deposit depends on the dealer but will normally be a percentage of the total cost. Usually, the higher the price of the deposit, the lower the monthly payments will be.
What is collateral?
Collateral is the asset or assets that you use to secure a loan. For car finance, the collateral could be the car itself, meaning that if the borrower fails to make payment back to the lender, the car could become the property of the lender. The higher the value of the collateral, the lower the risk to the borrower.
These tips should help unravel the confusing world of financing your first car. Remember to make sure you know what you are paying for and how much it will cost. If you’re still looking for your first car, have read through our car buying advice where we have step-by-step guides on what to check before buying a car as well as tips on maintenance and first car insurance.