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How does financing a car work?

When you finance a car, you pay for it in monthly instalments. This means you don’t need to pay a lump sum to buy it, but instead can spread the cost over an agreed period of time, though some car finance providers may also require a deposit.

Terms can range from 12 months to five years, although this will vary between finance types and providers.

The way the agreement works will depend on the type of car finance you choose. If you use a personal loan, then you simply make monthly repayments until you pay off the loan.

Hire purchase works in a similar way, but PCP is more complex as the monthly payments cover the estimated depreciation of the vehicle over the finance term rather than its total cost.

What are the main types of car finance?

There are several types of car finance available that all work in different ways. These include:

Car loans

Car loans are effectively personal loans that you can use to buy a car. You apply for a loan from a bank or online provider and, if accepted, you can use this loan to buy a car of your choice. Because you will be buying the car outright, you will own the car from the outset.

You will then make the agreed monthly repayments to the lender until you pay off the loan.

Hire purchase (HP)

When you buy a car with hire purchase, you put down a deposit and then take out finance to cover the remaining cost. You repay this amount in monthly instalments and, while you make repayments, the finance provider legally owns the car. At the end of the term, you can pay a small “option to purchase” fee to transfer ownership of the car from the finance provider to you.

Conditional sale is a similar form of finance to hire purchase but, instead of paying an additional charge at the end of the term to own the vehicle, you automatically become the owner after making the final payment.

Personal contract purchase (PCP)

Unlike hire purchase, with PCP you don’t pay off the full value of the car. Instead, your payments cover the estimated depreciation of the vehicle so, in other words, you pay the difference between the car’s value at the time of purchase and what its value is expected to be at the end of the term. Because you don’t pay off the car’s total value, monthly payments tend to be lower than other finance options.

At the end of the term, you can choose to keep or return the car. If you keep the car, you have to pay a final ‘balloon’ payment which is normally a substantial sum. This payment is based on the car’s Guaranteed Minimum Future Value (GMFV), which is approximately the car’s value at the end of the term.

Alternatively, you can choose to return the car to the finance provider at no extra cost.

» MORE: PCP car finance explained

Key features of car finance options

	Personal loan	Hire purchase	PCP
Own the car from the start	Yes	No	No
Finance secured against the vehicle	No	Yes	Yes
Pay monthly	Yes	Yes	Yes
Pay a deposit	No	Most cases	Most cases
Own the car at the end of the deal	Yes	Yes (if you pay the small final fee)	Only if you pay the final balloon payment
Mileage restrictions	No	No	Yes

Can I get car finance?

Whether you’re looking to buy a new or second-hand car from a dealer or private seller, you may be able to apply for car finance.

Providers have their own criteria and some types of car finance, such as PCP, are only available if you buy a car from a dealer, but there are many different finance options to cater for different people.

Your credit score, income and the amount you want to borrow will be some of the factors that will determine whether you can get car finance.

Car finance is available for those with poor credit scores too. There are specialist finance providers that can offer finance to those with poorer credit histories, and there are ways you can improve your chances of approval, such as getting a guarantor or putting down a bigger deposit.

With car finance if you have a bad credit history, it’ll be harder to get a new contract and if you are approved for one it is likely to be expensive.

» MORE: Can I get car finance with bad credit?

How to get car finance

If you plan to get a car on finance, it will be useful to have as big a deposit as possible. While there are some no deposit car finance deals, putting down a sizeable deposit means you won’t need to borrow as much.

You will also need to decide which type of car finance meets your requirements, as well as which car you want to buy. You’ll need to make sure that you choose a car and a finance deal that you can afford.

With different providers available, you should do some research and compare them to find the one most suitable for you.

When you’re ready to apply, you’ll need to give the finance provider some personal and financial information including your name, income, and how much you want to borrow. You don’t necessarily need to know the exact car you want to buy when you apply for finance.

Providers will also check your credit score as part of the application process.

What checks are done for car finance?

When you apply for car finance, the provider will conduct a variety of checks. For example, they will need information such as:

• your name, address and date of birth
• your income and employment status
• your credit score

Providers will use these details to determine whether to accept your car finance application and, if they do, what rate of interest to set.

» MORE: Car finance checks

How much does car finance cost?

The cost of car finance will depend on the cost of your car, the size of your deposit, the type of agreement you choose, and the interest rate you qualify for.

Typically, PCP will come with lower monthly repayments as you don’t pay off the total cost of the car. However, if you want to own the car, it can be more expensive in the long term, compared to hire purchase and a personal loan.

A good credit score and a bigger deposit can help you to qualify for more competitive interest rates and reduce the cost of your finance.

How to choose the best car finance for me

To help you choose the right kind of car finance, it’s worth considering:

• What car you want and how much it costs.
• How much you can afford to repay each month.
• Whether you want to own the car from the outset.
• Whether you eventually want to own the car or if you’ll want to change it after a few years.
• How long you want to borrow for, bearing in mind that the longer the term, the more interest you will pay.
• The terms of the finance agreement, such as the mileage restrictions on PCP contracts.

What are the alternative ways to finance a car?

If you have enough money in your savings, you could use cash to buy a car instead of using finance. Because you wouldn’t need to pay interest, using cash could be a cheaper option than finance, but only if you want to own the car for a long period of time.

Cars depreciate in value so, if you prefer to regularly upgrade your vehicle to a brand-new model, taking out a PCP agreement may be more suitable as you can return the car after the agreed term.

» MORE: What is the best way to buy a car?

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