Should I use car finance or a loan to buy a car?

There are lots of ways to pay for a new car and they all work slightly differently. It can be confusing trying to decide which is best for you, so here we will look at the difference between buying with car finance or a bank loan.

Rebecca Goodman Published on 05 July 2021.
Should I use car finance or a loan to buy a car?

Paying for a car with a loan means you own the vehicle outright and it can also be a relatively cost-effective option, although the cost will depend on your credit score and the interest rate of the loan.

Car finance works slightly differently as you don’t own the car until you pay off the finance in full. However, you can choose to return the car with some types of car finance, which isn’t possible if you buy a car with a loan.

Read on to learn more about when you might choose car finance or a loan to buy a car, and the pros and cons of each option.

Car finance vs loan

If you buy a car with a personal loan, you can split the cost over a number of monthly instalments at a set rate of interest. Terms can be up to seven years.

The contract is with the lender, usually a bank or online lender, and they are completely separate from wherever you choose to buy your car. You can use the money to buy a new car outright, or use it to pay for a portion of the car’s cost.

The cost of the personal loan will depend on your income and your credit score, with the best rates given to those with excellent credit scores.

Car finance also allows you to spread the cost of a new car over monthly payments (with interest), but the agreement is with a car finance provider rather than an independent lender.

You usually pay a deposit at the start of the contract, followed by monthly payments during the term of the contract, and then, depending on the type of car finance you have, you can either pay a lump sum to keep the car, swap it for a different model, or return it.

Here we outline the main differences between buying a vehicle with a loan and with car finance.

Personal loan Car finance
You borrow a set amount of money, and repay it in instalments over a fixed period. You pay a deposit, then monthly repayments at a set cost for a fixed period.
If you have a good credit score you could get a cheap interest rate. If your credit score isn’t good, car finance could be cheaper than an unsecured loan.
You own the car at the outset as your debt is with a financial institution not the dealership. You don’t own the car while you make payments. At the end of the contract, you can become the owner or return the car (depending on the type of agreement you have).
The car’s value will depreciate, so you could lose money over time. If you’re returning the car at the end of the contract, depreciation won’t be an issue.
You are responsible for the car and free to modify and drive it as much as you want. PCP car finance deals have limits on the number of miles you can drive, as well as other conditions.

Pros and cons of car finance

Car finance can be a useful way to help someone pay for their car, but it may not be suitable for everyone.

Pros of car finance

  • It spreads the cost of a brand new car across affordable payments.
  • You can choose to return the car if you have a hire purchase or PCP agreement.
  • There are different types of car finance available to suit different budgets and preferences.
  • You may be able to buy a more expensive car than you’d be able to pay for outright.
  • If your financial circumstances change and you can’t afford the repayments, you can cancel your car finance and return your car.

Cons of car finance

  • The interest costs are usually higher than a personal loan.
  • You don’t own the car until the contract has ended and you have made all the necessary payments.
  • If you fail to make repayments, it will damage your credit score and your car could be repossessed.
  • You may be charged a fee if you exceed any mileage limits on your PCP contract.
  • If there is any damage to the car when you return it, you'll need to pay for the repairs.

Pros and cons of a personal loan

A personal loan can be a cheaper overall option for buying a car, but this will depend on your credit score.

Pros of a personal loan

  • Interest rates on personal loans could make them one of the cheapest ways to borrow money.
  • When you buy the car, it’s yours from the beginning and you are able to modify it or sell it.
  • You can use the money to buy a car from any seller, not just from a dealership.

Cons of a personal loan

  • You’ll need to have an excellent credit score to be eligible for the best interest rates.
  • The car’s value will depreciate so you won’t get as much money back if you sell it.
  • Monthly payments can be higher than on PCP car finance.

Is car finance or a loan cheaper?

The cheapest option between a car finance contract and a personal loan depends on multiple factors including your credit score, your income, and the type of car you want.

If you have a good credit score and can access the best rates, a loan is likely to be a cheaper option than car finance.

However, buying with cash will likely be the cheapest way to buy a car because you don’t pay any interest.

To work out whether car finance or a loan is better value for money, you’ll need to add together all of the costs involved. This includes any deposit you’re required to pay, the interest on the contract, and any fees that may apply.

You can compare quotes to see what rates and deals you are eligible for, and use this information to help you find the cheapest available option.

But you shouldn’t just think about cost. You will also need to consider other factors such as how important it is for you to legally own the car, and also whether you will want to change cars in a few years.

Where can you get car finance or a personal loan?

There are lots of providers of both car finance deals and personal loans. Generally a personal loan can be applied for from a bank or online lender while a car finance deal is arranged through a dealership or a finance provider.

Whatever option you go for, it’s always worth shopping around to make sure you’re choosing the best priced plan for you and that you can comfortably afford it. It’s also worth seeing if you can improve your credit score to gain access to even more competitive rates.

You can compare car finance here and see what deals you are eligible for.

Alternatively, if you prefer to own your car outright from the start, you can look at and compare personal loans to see what rates are available. Make sure you are aware of the differences between an unsecured loan and a secured loan.

Image source: Getty Images

About the author:

Rebecca Goodman is a freelance journalist who has spent the past 10 years working across personal finance publications. Regularly writing for The Guardian, The Sun, The Telegraph, and The Independent. Read more

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