Car finance explained

Finding just the right car can be a challenge, and part of that challenge is deciding how to pay for it. We can help make that challenge easier by walking you through the available payment options to help you work out what’s best

• Why paying for a car with cash is best
• Credit scores and car finance
• Using a personal loan to buy a car: how it works
• Hire purchase
• Personal Contract Purchase (PCP): how it works
• Personal Contract Hire (PCH): how it works
• Buying a car on a credit card: how it works
• How to buy a car using a peer-to-peer loan
• Things to remember before making a decision
• Your next step

Why paying for a car with cash is best

As long as you keep enough savings to cover other major purchases or unexpected car costs in the future (our Car costs calculator can help you work out what running a car costs), paying cash is normally the cheapest way to buy your car.

Here are the main reasons why:

You own the car outright
Buying your car with cash means you own it straight away, so if you got into financial difficulties you could sell it.

If you’ve bought a car using a finance agreement such as personal contract purchase (PCP), personal contract hire (PCH) or hire purchase, the finance company owns the vehicle during the contract. This means you can’t sell it and if you get behind with your repayments, you might lose your car.

You save money while savings interest rates are low
While savings interest rates are low, it often makes sense to use savings rather than borrowing at a higher rate of interest.

For example, with £1,000 in a savings account earning 2% interest you would make £20 in interest in one year.

If you borrow £1,000 to buy your car, and you paid 9% interest you’d have to pay around £90 interest on the loan in one year. This means you’d be £70 worse off than if you used some of your savings to buy the car.

Tips for buying in cash
If you don’t have enough savings to buy the car outright, you could use what you can afford to put down the biggest deposit possible so you spend less on loan interest.

As long as you pay part of the cost of your new car by credit card you benefit from section 75 purchase protection on the full amount, as long as the car costs over £100. This can protect you legally if something goes wrong. Make sure to pay off your credit card balance straight away though.

Credit scores and car finance

If you’re not paying with cash, you’ll be using car finance or credit to buy your car. If you’re using credit, you’ll get the best deals if you have a good credit score.

Remember, just because your credit score is good and you’re allowed to borrow a larger amount, it doesn’t mean you’ll be able to afford it. You need to work out all your outgoings and be confident that you can make all the repayments for the full term of the credit deal.

If you get behind on your car payments, talk to your finance company or lender as soon as possible. You might be able to return the car or pay off the loan early.

Read more about ending lease agreements early on our Cutting car finance costs page.

Using a personal loan to buy a car: how it works

A personal loan from a bank or building society lets you spread the cost of buying a car over one to seven years.

• If you don’t have enough cash or savings to buy a car, personal loans are usually the cheapest way to borrow money over the long term.
• The monthly repayments can be higher than other options, but you own the car from the start of your loan and the total amount you pay should work out less than most other methods.
• If your credit score isn’t good you might find it difficult to get a loan.

If you think you have a bad credit score, there are ways to improve your credit score.

Hire purchase

This is a simple type of car finance. You usually pay a deposit of around 10%, then you make fixed monthly payments over an agreed period.

Here’s what you need to know:

• The car isn’t yours until after the final payment, unlike with a personal loan. This means the loan is secured against the car, so if you miss payments, you could lose the car.
• Hire purchase agreements are set up by the car dealer, and brokers also offer the service.
• Rates are best for new cars, so check what you’ll be paying if you’re buying a used car.

You have certain consumer rights with hire purchase agreements.

• Once you’ve paid half the cost of the car, you might be able to return it and not have to make any more payments – check your contract to see if this applies to you.
• Once you’ve paid a third of the total amount you owe, your lender can’t repossess your vehicle without a court order.

Personal Contract Purchase (PCP): how it works

A Personal Contract Purchase (PCP) is a more complicated way to pay for a car. It’s like hire purchase, allowing you to use the car until the contract ends. At the end of the contract, you can either:

• Return the car.
• Pay the resale value and keep it.
• Use the resale value towards buying a new car.

You need to be aware of how a PCP works to make sure it’s right for you.

Here are the steps to getting a PCP deal:

1. You’ll need to pass a credit check before the PCP is set up. However, your ability to make the monthly repayment will not be checked. Before you sign up for a PCP deal, it’s really important to make sure you have worked out that you can really afford to meet all payments over the whole term of the contract, which could last up to four years.
2. You’ll need to pay a deposit, usually 10% of the value of the vehicle.
3. Use the car and make your payments for the duration of the contract. Make sure you stay within your mileage restriction. There will be charges if you go over your limit.
4. If you want to keep the car, you’ll need to make a final payment, often called a balloon payment. This is based on what the dealer thinks the car is worth now – its Guaranteed Future Value (GVF) and can range from a few hundred to a few thousand pounds. It will be a larger payment than your monthly payment. If you haven’t got this money saved, you may have to take out another loan to pay it off.
5. If you’re not going to keep the car, you can hand it back without any further payments.

Alternatively, you can offer to pay off the GVF and put down another deposit for a new car.

Here are the important points to know about PCPs:

• Always check your contract and terms and conditions to make sure you understand any fees and what happens if your situation changes and you need to alter your agreement.
• Make sure you know how much you’re paying back – often you’ll pay more with a PCP than with other types of car finance.
• You’ll usually be charged for exceeding your agreed mileage.
• Excessive wear and tear and damage, such as scratches, can mean you’ll receive additional charges.
• To end the deal early or cancel it, you must have paid half the value of the vehicle. If you haven’t, you’ll need to pay the difference before you can get out of the contract. The car will need to be in good condition too, or you might be charged for repair costs.
• If you plan to take your car abroad, check your PCP contract as some companies will impose a limit on the number of days your car can be out of the country.

Personal Contract Hire (PCH): how it works

A personal contract hire (PCH) plan is a form of car leasing where you never own the car.

If you’re not planning to buy the car at the end of a PCP, a PCH might be a cheaper option.

Here’s how PCH works:

1. You will need to pass a credit check and pay a few months’ lease upfront, typically three months’. Although you may pass the credit check, companies don’t check whether you can afford the monthly payments. It’s up to you to make sure you have worked out that you can pay what you’re agreeing to. It’s really important that you’ve thought about all your outgoings before you sign any deal and that you’re confident you’ll be able to meet repayments for the full length of the contract.
2. Use the car, sticking to your mileage agreement to avoid extra charges. With a PCH, costs such as servicing and vehicle excise duty (car tax) are included, so you only need to pay for fuel.
3. Keep the car in good condition. Any damage not allowed in your terms and conditions might mean you get extra charges.
4. Return the car at the end of the agreement.

Here are the important things to know about a PCH:

• Always check your contract and terms and conditions to make sure you understand any fees and what happens if your situation changes and you need to alter your agreement.
• If you go over the mileage in your contract, you’ll usually be charged extra fees.
• You never own the car and have to return it at the end of the contract term.
• If you want to end the contract early, you usually have to pay some charges. Check your terms and conditions before you sign up so you’re prepared if you need to get out of the contract.
• When you return the car, it must be in good condition. Normal wear and tear is usually allowed, but this depends on your agreement. Any damage that isn’t covered might mean you have to pay extra charges.

Buying a car on a credit card: how it works

Using a credit card to pay all, or part, of your car’s purchase price will give you extra protection on the full purchase cost – as long as the value of the vehicle is over £100 and less than £30,000, and you meet your monthly card payments.

That means you could pay a small deposit of £20 on a car worth £5,000, pay the rest using a debit card, and still have credit card payment protection.

However, some dealers might not accept credit cards at all.

Remember that interest rates on credit cards can be higher than other types of finance. A 0% deal is usually best, as you can pay off the loan over several months without having to pay interest. If you haven’t got a 0% deal, pay the balance off straight away to avoid interest.

How to buy a car using a peer-to-peer loan

This is borrowing and lending between individuals through websites such as Zopa.

Although peer-to-peer loans bypass traditional financial institutions such as banks or building societies, you still need a good credit score to get the best rate.

Things to remember before making a decision

The more you make on it, the less money you’ll need to raise for your new car.

If you’re thinking of taking out a personal loan or car finance arrangement, here are some things to think about:

• Remember with leasing, you’re charged a fee if you repay early or exceed the forecast mileage.
• Compare the total cost of borrowing, including interest and all charges over the term of the loan.
• Ask yourself whether you’ll be able to afford the car’s running costs on top of your monthly payment. Check your budget then calculate the running costs. Try our Car costs calculator tool.
• Compare interest rates by looking at the annual percentage rate (APR), which includes the interest rate plus all other lender’s charges. The larger your deposit, the lower the interest rate is likely to be.
• Think carefully before buying payment protection insurance or GAP insurance cover, which pays out if your car is stolen or written off. Both can be expensive and might give limited cover.

Your next step

This article is provided by the Money Advice Service.