Car finance: How to find the best car financing for you

Car finance is an essential part of the car-buying process for many people. According to the Finance and Leasing Association, UK consumers bought nearly 680,000 new cars on finance in 2022 and a whopping 1.5 million used vehicles. 

Whether you’re buying a new or used car, car finance can help you spread the cost of your purchase. With so many different options available, it can be hard to know where to start. In this article, we’ll take a closer look at car finance and offer some tips on how to find the right option for you.

Car finance covers a variety of options available for you to buy a car if you don’t have enough cash to pay the total amount upfront. Typically, it’s a type of loan specifically designed for the purpose of buying a car, however there are more conventional loans and lease options also available. 

There are several different types of car finance available, including hire purchase, personal contract purchase (PCP), and personal loans. It also includes leasing as an alternative option if you want to simply use a car for an agreed period of time but don’t want to own it outright.

With several options available when browsing for cars on finance, it can quickly become confusing to understand the best option for your needs and budget. Once you have decided on the car that’s best for you, there are a few things to consider before moving forward with a finance option:

1. Which cars on finance option is best for you? Whether you’re looking to spread the cost of a car, change it frequently, or simply want to use a car and never actually own it, there are specific car financing options that will be best suited to your needs. Below, we explain the differences and things to keep an eye out for when considering which option is best for you.
2. Agree appropriate length and terms of the contract. It’s a smart idea to nail down a budget for your monthly car costs, especially as the cost of the car, your deposit amount, the annual percentage rate (APR) and term of the contract will affect the amount you’ll pay each month. Additionally, some car finance options require you to agree to certain conditions, such as a limit on your annual mileage. Again, the higher you go, the more it will cost you per month.
3. You will be borrowing money. Like any loan, car financing does carry some risks.  Missing payments can damage your credit score, lead to the repossession of the car and even result in county court judgements.  
4. What happens when the contract ends? Depending on the option you choose, at the end of the contract you may have repaid the loan in full and bought the car outright. Alternatively, you may have the option to either pay an outstanding sum to purchase the car, or return the car and walk away. If the car still suits your needs but you don’t want to purchase it outright, you can also start a new car finance agreement.

Hire purchase (HP) is a type of car finance agreement that allows you to buy a car through monthly payments over a fixed term (usually two to five years) with interest. With HP, you pay an initial deposit and then spread the remaining cost of the car over the term of the agreement.

At the end of the HP agreement, you own the car outright, provided you have made all the monthly payments and any final payment that may be required. HP agreements are typically used for buying new or used cars and can be arranged through car dealerships or finance companies.

During the HP term, you are responsible for maintaining the car and keeping it in good condition. You are also responsible for any repair or maintenance costs that arise during the term of the agreement.

HP can be a good option if you want to eventually own the car outright and keep it for a long time. However, it’s important to carefully consider the terms and costs of the agreement, including the interest rate and any fees, and to make sure the monthly payments fit within your budget before entering into an agreement.

A personal contract purchase (PCP) is a type of car finance agreement that allows you to use a car for a set period of time (usually two to four years) in exchange for monthly payments. With a PCP, you typically pay a smaller monthly payment than with other types of finance agreements, such as hire purchase (HP), because you are only financing a portion of the car’s value. A PCP agreement can be a little tricky to understand at first, but you can break it down into three parts:

1. Upfront deposit: Typically around 10 per cent of the car’s value
2. The monthly payments: This is the trickiest element of the PCP agreement. The monthly payments are calculated by the finance company by predicting how much the car’s value will drop over the term of the agreement (often termed the depreciation of the car). Essentially, your monthly payment only covers the amount of value the car will lose over the course of the agreement (less the deposit).For example, let’s say you want to purchase a car worth £20,000 and choose to take out a three-year PCP agreement with a £2,000 upfront deposit and 0 per cent interest rate to make the maths easier. In this case, the total loan amount is £18,000. This loan amount would then be split into two parts – the monthly payments payable over the three years and the optional balloon payment, which you can pay at the end to purchase the car outright (see point three below).To calculate the monthly payments, the finance company would estimate how much the car will be worth at the end of the three years and deduct the deposit already paid. For example, if your £20,000 car is predicted to be worth £10,000 after three years, the monthly payments will total £8,000 over the three years (or £222.22 per month, to be precise). This will be paid by you in monthly instalments plus interest over the course of the agreement. Note that £8,000 will be subject to interest.
3. The balloon payment: This is also known as the Guaranteed Minimum Future Value (GMFV) or optional final payment and is agreed when you sign the agreement. Using the example above, at the end of three years, you would have the option to pay the £10,000 the car is worth to own it. You will pay interest on this payment as well.

At the end of the PCP term, you have three options:

• Return the car: You can simply give the car back  to the finance company with no further commitments, provided the car is in good condition and has not exceeded the agreed mileage limit.
• Keep the car: You can pay the balloon payment to own the car outright.
• Trade in for a new car: You can trade in the car and use any equity towards a new PCP agreement, similar to a part exchange.

During the PCP term, you are responsible for keeping the car in good condition and maintaining it according to the manufacturer’s recommendations. You will also need to stay within the agreed mileage limit, or you will be charged for excess mileage.

PCP can be a good option if you want to drive a new car every few years, have lower monthly payments than with HP, and have flexibility at the end of the term. However, it’s important to carefully consider the terms and costs of the PCP, including the interest rate and fees, and to make sure it’s the right option for your individual needs and circumstances.

Personal loans are a type of unsecured loan that can be used for a variety of purposes, including buying a car. With a personal loan, you borrow a set amount of money and then make regular monthly payments to repay the amount borrowed plus interest. 

Unlike hire purchase or PCP, buying a car through a personal loan means you own the car outright as soon as the purchase is made. At the end of the loan period, assuming you have made all the repayments, the lender will deem the loan settled and you will have nothing left to pay. 

While you technically own the car from the outset, it is important to continue to make your loan repayments on time. If you miss several repayments, the lender will mark you “in default”, which will be logged on your credit file and harm your chances of being able to borrow money in the future (including for other big purchases such as a mortgage for a home). 

It’s important to contact your lender well in advance if you think you will fail to make a repayment, as typically they will try to work out a new repayment plan to suit your circumstances. The worst-case scenario to avoid is to keep missing payments without letting your lender know. If this happens, lenders can apply to a court to allow a bailiff to seize your car or other items you own up to the value of the car.

Car leasing is a form of long-term rental that allows you to use a vehicle for a set period of time (usually two to five years) in exchange for monthly payments. When you lease a car, you are essentially paying for the use of the vehicle, but you do not own it. Instead, the leasing company retains ownership of the car throughout the lease term.

At the end of the lease term, you can return the car or buy it for a predetermined price. Leasing can be a good option if you want to drive a new car every few years and avoid the responsibilities and risks of ownership. However, leasing may not be the best option if you plan to keep the car for a long time, or if you drive more than the mileage limit set by the leasing company. It’s also worth noting that a lease agreement is difficult to exit early without significant penalties. This means you are locked in for the period to both the car and the payment, unlike other forms of financing, where you can settle the finance and sell the car at any time if you have a change of circumstances.

When you lease a car, you will typically need to make an initial payment, as well as monthly payments throughout the lease term. Technically, a lease is not an interest-bearing agreement, but some leasing companies will include a charge in the monthly payments to cover the investment they have made in buying the car for you to rent. You will also be responsible for maintenance and repair costs, as well as any excess wear and tear on the vehicle. Most leasing companies do offer the option for an add-on maintenance package, meaning they are responsible for maintaining the car, however this does increase your monthly payment. Additionally, most leases come with mileage limits, and you will be charged extra for any miles driven over that limit.

Overall, car leasing can be a good option if you want to drive a new car every few years and avoid the responsibilities of ownership. However, it’s important to carefully consider the costs and terms of the lease, as they can be pricey to exit early if you have a change in circumstances.

While lenders will be the ones setting the terms of any car finance agreement, there are some steps you can take to lower your monthly repayments. Here are some tips for getting cheaper deals:

• Opt for a larger deposit: The more money you can put down on a car up front, the less you’ll need to borrow and the lower your monthly repayments will be. A bigger deposit might also trigger a lender to offer you a lower interest rate. If you already have a car, consider using it for a part exchange deal rather than selling it, and add cash on top to boost your down payment.
• Shop around: Set a realistic expectation for the kind of car you can afford. Research cars that fit your budget and choose the one that matches your wish list but doesn’t break the bank, then look at the deals on offer for that model at several different dealers and choose the best one. 
• Find the lowest APR: It’s a good idea to look at the interest rates on offer from several lenders, as not all of them will offer the same rates. Bear in mind that a poor credit rating might impact your ability to get a lower APR – we’ll touch on that later.
• Pay attention to extras and fees: Some finance agreements have “hidden” costs, such as fees for excess mileage or damage to the car, or a penalty for ending the agreement early. Make sure you check any deal you’re considering for these extras and consider whether you can afford to pay them.
• Choose the right mileage allowance: Some car finance agreements will place an annual limit on how many miles you can drive. This is especially true for financing that is dependent on the value of the car at the end of the term, such as leasing or PCP. Choose a mileage allowance that is realistic for your circumstances – too much allowance will see you paying more than you need to, while too little could mean a large sum of fees at the end of the agreement.
• Go for a longer agreement: If you’re only concerned with getting lower monthly repayments due to a restrictive budget and aren’t worried about the overall cost, it’s worth considering a longer-term agreement, particularly if you choose HP or a personal loan. You’ll end up paying more in interest (and therefore more overall), but spreading the cost over five years as opposed to three could see you paying less on a monthly basis.

When it comes to choosing the right car finance option for you and your circumstances, there are several factors to consider. These include:

• Interest rates: Different car finance options will have different interest rates. It’s important to compare rates and choose the most competitive deal.
• Deposit: Some car finance options will require a deposit up front. You should consider whether you have the funds available to pay a deposit and how much you can afford to pay.
• Monthly payments: You should consider how much you can afford to pay each month when choosing a car finance option. Make sure you can comfortably afford the monthly payments for the duration of the agreement.
• Total cost: When comparing car finance options, it’s important to look at the total cost of the agreement. This includes any interest charges and additional fees.
• Mileage restrictions: Certain car financing options, including PCP and leasing, come with annual mileage restrictions that cover the period of the contract. These are typically anywhere between 6,000 to 30,000 miles. For context, if you drove from London to Reading and back three times a week for a year, this would total approximately 13,000 miles over the year. If you exceed the mileage restrictions, the lender or leasing company will typically charge an excess mileage fee for every additional mile.  This can range from 3p to 30p per mile, which doesn’t seem like much but adds up quickly if you go way beyond your limit. Be sure to choose an agreement that offers a mileage allowance matching your typical usage.
• Who owns the car? In most of the car financing options we’ve outlined, you do not own the car until you have paid off the total amount of the agreement, including monthly payments and the final balloon payment in the case of PCP. With leasing arrangements, the car is always owned by the lease company. If you purchase a car with your own cash or through a personal loan, you will own the car outright from the moment you complete the sale.

In the below table,  we have simplified the differences between the various car financing options available to you.

It may be possible to get car financing with bad credit, but it can be more challenging than if you have a good credit score. Many lenders consider your credit score and credit history when deciding whether to approve a loan application and what interest rate to offer. If you have bad credit, you may be seen as a higher risk borrower, and as a result, you may be offered a higher interest rate or be required to provide a larger deposit.

Here are a few options to consider if you have bad credit but need car financing:

1. Improve your credit score: Before applying for car financing, it’s a good idea to check your credit score and see if there are any ways you can improve it. This could include paying off outstanding debts, paying your bills on time, and disputing any errors on your credit report. Be aware that these changes will take some time to be reflected in your score.
2. Look for specialist lenders: Some lenders specialise in providing car financing to people with bad credit. These lenders may be more willing to consider your application and offer you financing at a higher interest rate or with a larger deposit.
3. Consider a guarantor loan: A guarantor loan is a type of loan where someone else agrees to be responsible for the repayments if you can’t make them. This could be a family member or friend who has good credit.
4. Save for a larger deposit: If you can save up for a larger deposit, this can improve your chances of getting approved for car financing with bad credit. A larger deposit can reduce the amount you need to borrow and make you a less risky borrower in the eyes of the lender.

Ultimately, while getting car financing with bad credit can be more challenging, it’s not impossible. By exploring different options and taking steps to improve your credit score, you can increase your chances of getting approved for financing and securing the car you need.

Many people rely on car finance to buy a vehicle, whether it’s a new car or a used one. There are several different car finance options available, each with its own advantages and disadvantages. When choosing a car finance option, it’s important to consider factors such as interest rates, deposits, monthly payments, and total cost. By taking the time to compare options and choose the right one for you, you can get behind the wheel of your dream car and spread the cost over a period of time.