The different types of car finance explained
There are several different types of car finance available which can make it difficult to decide which is the best one for you. From hire purchase to PCP to leasing, we explain how each car finance option works and the pros and cons.
Car finance can be complicated. There are various types available on the market for people looking to fund the purchase of a car, but if you choose the wrong package, you can rack up lots of interest and extra charges making the car significantly more expensive than if you’d paid in cash.
On the other hand, the right finance for your circumstances can help you make a purchase that fits your personal financial plans.
Paying up front will be cheaper, but if you don’t have the funds to do this, finance will help you to afford a car.
Read on to find out what each type of car finance is, the pros and cons, and which might suit your financial circumstances the best.
Hire purchase is a type of car finance which allows you to own a car at the end of your finance plan, after securing the car with a relatively low deposit and monthly payments.
Hire purchase is a secured loan, with the car used as collateral against the amount of the loan. After paying a deposit – usually part of hire purchase car finance plans, but not always – you pay agreed monthly payments.
The structure of hire purchase means that you won’t own the vehicle until the full amount is paid. To own the car outright, you would normally need to pay an “option-to-purchase” fee at the end of the agreement, as well as the final monthly repayment.
If you’re paying a deposit – it will often be a minimum of 10%, although you can pay more if you choose – you will reduce the amount of the loan, and therefore the amount of interest you will pay, and you’ll pay the loan off quicker.
The loan term of a hire purchase agreement is typically from one to five years and varies between providers.
Pros and cons of hire purchase
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» MORE: What is hire purchase?
Similar to hire purchase, a conditional sale is a method of acquiring a car on finance. You’ll typically pay a deposit backed up by equal monthly repayments over the course of the loan’s term.
Conditional sale can sometimes be confused with hire purchase. The key difference is that there’s no “option to purchase” fee with a conditional sale. You will automatically become the vehicle’s new owner at the end of the loan term when you make all the repayments.
There are no mileage charges with a conditional sale, and most hire purchase agreements also don’t have mileage restrictions.
Pros and cons of conditional sale
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» MORE: What is conditional sale?
Personal contract purchase
Personal contract purchase (PCP) is a form of car finance with similarities to hire purchase as individuals will pay a deposit for use of the car and then repay the loan amount in monthly instalments.
However, the difference with PCP is that the borrower doesn’t repay the total cost of the car in equal monthly payments. Instead, they pay lower monthly instalments to cover the vehicle’s depreciation and then choose to pay a larger sum at the end of the contract to own the car. This sum is called a balloon payment
The balloon payment is based on the guaranteed minimum future value (GMFV), which is set by the manufacturer at the beginning of the contract based on what they estimate the car will be worth at the end of the agreement.
All being well, the vehicle will be worth more than the GMFV. This would mean that, if you choose to return the car, you could use the car’s value to clear the outstanding finance and use the remaining value towards a deposit on a new finance plan.
A PCP plan is usually between 3-5 years.
Pros and cons of PCP
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» MORE: What is PCP car finance?
If you don’t have the available cash to buy a car outright, you could take out a personal loan. Providing you have a good credit score and can keep up with the repayments, a personal loan could be a way to finance your car purchase.
With a personal loan you can spread the cost of a car over a certain time period but, unlike car finance options, you will be the legal owner of the vehicle from the start.
Pros and cons of buying a car with a personal loan
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» COMPARE: Find personal loan deals
Personal leasing car finance allows you to drive a new car every few years. This form of car rental is available on new cars and each plan usually runs for between two and four years.
When the lease ends you’ll return the car to the leasing company; there’s no opportunity to own the car, so personal leasing suits those that prefer flexibility. If you only need to drive for a number of years before moving home to a city where you have other transport options, or you want to regularly change cars so you’re always driving the latest model, personal leasing could be suitable.
Personal leasing tends to be cheaper than hire purchase or conditional sale car finance with generally lower monthly payments. But remember, you’re not paying towards owning the car, you’re simply paying a rental fee for the use of the vehicle.
As brand new cars, vehicles rented with personal leasing are usually under the manufacturer’s warranty; this means you won’t have to foot the bill for any expensive repairs.
Many dealerships offer GAP insurance policies with leased cars. If your leased car is stolen or written off, your car insurance would pay out the amount your car is worth at that time. However, this may not cover the amount you need to pay the leasing company.
GAP insurance would pay the difference between the amount left to pay on your lease and the current market value of the vehicle, which means you wouldn’t have to pay the remaining costs of the contract yourself if the car is stolen or written off.
» MORE: What is GAP insurance?
Pros and cons of personal leasing
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Guarantor car finance
Guarantor car finance is designed to help drivers with poorer credit scores access finance to buy a car. When you apply for this finance, you will need to name a guarantor who agrees to make the repayments should the borrower miss any.
The applicant is still responsible for the repayments, but naming a guarantor mitigates some of the risk for the finance company.
Guarantor car finance could also be an option for younger drivers with limited credit history who may struggle to get accepted for finance on their own.
The exact types of guarantor finance available will vary between providers.
Pros and cons of guarantor car finance
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» MORE: What is guarantor car finance?
Comparing your car finance options
When you’re looking for the best deal to suit your driving needs and financial circumstances you want as much choice as possible to ensure you’re getting favourable terms.
Remember, if you do your own research you will have more choice than taking out finance directly with the dealership and may get a better deal.
Take your time when considering which type of car financing deal is right for you. Make sure that you fully understand the type of car finance you’re taking out, and if you will be able to afford both the repayments and running costs.
Finance providers may have some variations on the products explained in this article. It’s always important to thoroughly check all the details of any finance agreement you decide to take out.
» COMPARE: Get quotes for car finance deals
Rhiannon is a financial writer for NerdWallet, with a particular interest in personal finance and insurance guides for consumers. Read more