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A Beginners Guide to Car Finance

03-03-2023
A Beginners Guide to Car Finance

When you’re buying a new car, almost every dealer or car broker will offer a finance scheme. Car finance can be a confusing process with many different options to choose from. But, with sufficient research you’ll be able to make an informed decision about the best car finance option for you.

In this article, we’ll explain what car finance is, the different types of finance plans and the advantages of each, as well as everything you need to be eligible for car finance. 

What is Car Finance?

Car finance is essentially a loan that you take out to purchase a car. The loan can be from a bank, finance company or car dealership. Instead of paying for the car upfront, you make monthly payments to the lender over a set period of time. The lender will charge you interest on the loan, which is the cost of borrowing money. 

For those who cannot make the purchase outright, dealers usually offer several different financing options to make buying a car more accessible and affordable. It allows you to spread the cost of the car over several years. 

With various financing options out there, it’s important that you make the best choice for you and your personal circumstances. Luckily, most people are able to find a finance plan that perfectly suits their budgets and interests. 

What are the Different Types of Car Finance?

There are several different types of car finance available, each with their own set of advantages and disadvantages, depending on the individual. We explore more about the different types of car finance below: 

Hire Purchase (HP)

With HP, you pay a deposit upfront and then make monthly payments to the lender over a set period of time. At the end of the agreement, you will become the owner of the car. This is a popular option for people who want to own the car outright at the end of the finance agreement.

Typically, you pay a deposit of around 10% then begin to repay the balance in instalments, plus interest, over the loan period. You cannot sell the car without the lender’s permission until you have made the final payment and the car is rightfully yours. However, you can still return it to the lender if you need. 

One thing to keep in mind is that the car can be repossessed if you fail to keep up with your payments. Depending on the terms and conditions of your deal, servicing of the car might be included too. 

Personal Contract Purchase (PCP)

PCP is where you pay a deposit upfront, then make monthly payments to the lender over a set period of time. It differs from HP finance in that at the end of the agreement, you have the option to either pay a lump sum (or ‘balloon payment’) to own the car outright, hand the car back or use the equity in the car to purchase a new one. This is a popular option for people who want to upgrade their car every few years. 

With this option, you should be aware that it’s important to stick to the agreed mileage limits and keep the car in excellent condition in case you want to return it. Remember that you are hiring the car and will not rightfully own it until the lump sum is paid off. If you’re planning on keeping the car afterwards, this could be a less cost-effective option than HP financing. 

PCP and HP are the most common types of car finance, with many similarities but a few key differences. To learn more about which option is right for you, see our article: PCP Vs HP Finance - Which Should I Choose?

Personal Loan

A personal loan is where you borrow a lump sum of money from a bank or finance company, then pay it back to the lender over time. Unlike HP and PCP financing, you own the car outright from the start. 

This is a common way to finance a car purchase, as the loans often have lower interest rates and can be used to buy a new or used car. Although the APR may be high, you won’t have to pay a deposit, and you can spread the loan over a time period of your choice. 

It’s important to note that you’ll only be able to get a good loan term if you have a clean credit rating. There may be penalties for settling the loan early, and you have the pressure of dealing with the vehicle’s depreciation. 

Personal Leasing

Leasing a car is similar to PCP in that you make small monthly payments to use the car, but you don't own it at the end of the contract. Leasing is a good option for those who want to use a new car for a fixed period of time, without worrying about depreciation or selling the car once the contract ends. 

The type of car, length of contract and agreed mileage limits all factor into the leasing cost. You are normally obligated to pay up to three months’ rental in advance. 

Want to learn more? Our eligible audience can access exclusive discounts on car leasing deals. Visit Motorfinity Leasing to find out more. 

Credit Card

Using a credit card to buy a car, just like any other large purchase, is another financing option. This is not usually recommended due to the high interest rates associated with credit cards. If you are unable to pay off the balance in full at the end of the month, the interest charges can quickly add up.

The APR may be very high. Also, not all dealers will accept credit cards, and may impose additional fees if they do.

What do you need to get car finance?

When you're looking to get a car finance deal, there are a few things you need to have in place in order to be eligible:

A Good Credit Score

Like with taking out any loan, lenders will look at your credit score to determine whether you're eligible for car finance.

Steady Income

You'll need to demonstrate that you have a steady income, from either an employer or self-employment. This helps the lender to determine whether you'll be able to make the monthly repayments on time.

Proof of Identity and Address

You'll also need to provide proof of your identity and address. This is typically in the form of a passport or driving licence and a utility bill or bank statement.

Deposit

As previously mentioned, many lenders will require you to make a deposit towards the car's purchase price. The deposit amount will depend on the lender and the type of finance you are taking out. 

Information About the Car

You'll need to provide some information about the car you're looking to buy, such as its make, model and age. Some lenders may have restrictions on the type of car you can finance, so it's important to check this before applying.

Explore New Cars & Car Finance Deals

Through our associated car finance company, FinanceFinity, eligible customers can access exclusive low-rate car finance deals. Visit financefinity.co.uk to learn more, or browse our brand new discounted cars for sale on the Motorfinity website, for NHS staff, members of the police, the armed forces, teachers and all UK service personnel and carers

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