How does car finance work?

How does car finance work in the UK?

Financing a car is a way to cover the cost of a vehicle without paying the full cash price in one go.

You’ll be able to pay for the vehicle across an agreed-upon payment plan, usually with monthly payments, depending on the type of car finance you choose.

There are a few different ways to finance a car, but the most popular choices are Personal Contract Purchase (PCP), Hire Purchase (HP) and personal loans.

You might also choose to pay for your car with a credit card or lease the vehicle instead of buying.

You’ll likely find different types of car financing beneficial depending on your needs and budget.

It’s important that you understand the terms of your car finance agreement, and make sure you choose the right type of finance for your needs.

Once you’ve borrowed this money, you’ll spend a specific length of time paying off the loan.

With PCP and HP finance, you’ll own the car once you’ve finished paying, but you’ll own it from the beginning if you pay with a credit card or personal loan.

• Car finance with cinch

How does PCP work?

PCP works by spreading the depreciation amount of the vehicle across monthly payments, based on how much your car will be worth at the end of your contract.

This is known as Residual Value (RV) or Guaranteed Minimum Future Value (GMFV).

If you decide to keep the car when your contract comes to an end, you’ll pay an optional final payment that will cover the rest of the balance and make you the legal owner of the car.

Until you've paid all the monthly payments and the final balloon payment, you won’t legally own the vehicle.

This means you can hand it back at the end of your contract and choose a new car if you fancy it.

The final balloon payment will be pre-agreed before you start your PCP car finance deal, so you won’t be hit with any unexpected costs.

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Benefits of PCP

• Monthly payment amounts might be lower than other types of finance, as you’re not covering the full cost of the car

• You’ll avoid paying the full price of the car straightaway and can choose a payment plan that suits your budget

• You can hand back your car at the end of your contract without paying the balloon payment, meaning you won’t need to sell or part-exchange your current car before getting a new one

• You can choose flexible repayment terms, usually from 12 months up to five years

Things to consider before choosing PCP

• You’re not the legal owner of the car until you’ve paid the monthly payments and the final balloon payment, so you can’t modify or sell the vehicle without the lender’s permission

• If you go over your mileage limit, you'll usually be charged excess mileage fees

• If you damage the car beyond normal fair wear and tear, you’ll usually be charged for the repairs

• You’ll be making payments that include interest, as well as the cost of the car

How does HP work?

HP is a type of car finance that allows you to spread the cost of your car across monthly payments, but you won’t have a final balloon payment at the end of your contract.

You’ll pay a deposit at the start of your HP finance agreement, and then cover the rest of the costs across your monthly payments.

HP car finance is a straightforward finance option where you’ll simply be paying the cost of the car plus interest, across monthly payments.

Once you’ve paid a deposit and have decided on the length of your finance agreement, you’ll begin paying your car finance until you reach the end of your finance term. At this point, you’ll be the legal owner of the vehicle.

Before your contract comes to an end, there will usually be a small ‘option to purchase’ fee to take ownership of the car. You’ll be made aware of this before your HP contract starts.

HP is a good choice if you know you’ll want to keep your car and become the legal owner, and don’t need the option of handing your car back when you finish paying the balance.

Benefits of HP

• You’ll be the legal owner of the car as soon as you finish your car finance payments

• Some lenders still offer HP car finance to applicants with poor credit history as the finance is secured against the car, but interest rates might be higher

• Unlike PCP, HP finance usually has no mileage restrictions or excess mileage charges

• You don’t need to worry about damage charges unless you choose to terminate early, as you won’t be handing the car back at the end

Things to consider before choosing HP

• You’ve committed to purchasing an HP finance car and won’t have the option of a final balloon payment. You’ll have to terminate early to hand back the car

• Your monthly finance payments might be higher than PCP as you’re covering the full cost of the car

• You’ll still need permission to sell or modify the car, as you won’t be the legal owner until you’ve paid the full balance

• You’ll need to pay a deposit at the start of your contract

How does personal loan car finance work?

A personal loan is another way of financing a car but is slightly different from PCP or HP finance.

If you want to finance your car using a personal loan, you’ll need to apply to your bank or other lender.

They’ll then let you know if you’ve been approved, and the money will be sent to your account.

You can then use this money to cover the cost of your perfect car, meaning you’ll be the legal owner as soon as you pay.

You'll be able to sell the vehicle at any time as well as make modifications.

You’ll usually apply for a personal loan from your bank, and the money will be deposited directly into your account so you can purchase your car.

You’ll then repay the loan across your monthly payments.

Unlike PCP and HP car finance, your loan will not be secured against your car.

This means that your vehicle will not be taken as collateral if you stop making your finance payments.

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Benefits of personal loan car finance

• You’ll own the car straightaway so can make modifications and sell it before paying off your loan

• There’s no need to consider excess mileage or damage charges

• You may end up paying less overall if you can find a deal with low interest rates

• There’s no final balloon payment or deposit to consider

Things to consider before choosing personal loan car finance

• There’s no option to hand the car back at the end of your contract, so you’ll have to part-exchange or arrange a sale when you want to change your car

• You might have to wait a while for the funds to come through, depending on the lender. Often, you’ll receive the money within 24 hours

• You might not be eligible for the advertised interest rates even with a good credit score

Is car finance a good idea?

Car finance is a way to break the large upfront costs of buying a vehicle into manageable chunks and spread it over a longer period.

If you know you can manage the payments and can commit to keeping on top of them, car finance is a great way to enjoy a new vehicle.

There are also benefits when it comes to picking the type of finance deal – you can choose the arrangement that best suits your needs.

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What are the risks of getting a car on finance?

If you know that you might struggle to cover the regular payments on your contract, a finance arrangement is unlikely to be the best option.

If you miss payments on your finance deal, you could be at risk of losing your car and damaging your credit score.

You’ll also need to be certain you’ve picked the right finance type for your needs, and understand the terms and conditions, as some contracts will include excess mileage charges or other terms you need to be aware of.

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How to apply for car finance: PCP and HP

Getting car finance might be different depending on the type of finance you choose.

1. Once you’ve chosen your perfect car, you can use our car finance calculator to get a quote for your finance deal. For PCP and HP, you’ll need to put down a deposit. This will help calculate the rest of your monthly payments.

2. When you’re happy with your quote, you can apply online by supplying details like your address history

3. Once you’ve submitted your application, lenders will review it to check if it’s affordable for you. With cinch, our lenders will usually get back to you within 24 hours.

4. If you’ve been approved for finance, you’ll receive your car finance offer and can look forward to getting on the road

5. You’ll then start to repay your car finance each month on the date laid out in your contract.

How to apply for a personal loan

The process of applying for a personal loan is very similar to applying for car finance, except you’ll likely be applying through a bank, rather than a specialist car finance lender.

There are loads of options for personal loans, so make sure you do your research to see what suits your circumstances, and where you can get the best deal.

1. Shop around for the best interest rates until you find a deal that suits your needs

2. Supply your details, like address history and affordability factors, so the lender can decide if you fit their eligibility criteria

3. Once you’re accepted for a loan, the funds will be deposited into your account. The length of time this takes will depend on the lender

4. As soon as you have the funds, you can go ahead and purchase your new car

Just like with PCP and HP car finance, you’ll then start repaying your loan on a monthly basis. This will be on a regular date specified in your contract.

How to get the best car finance deals

Getting the best car finance deal will largely depend on your own circumstances, as deals are often tailored specifically to the person applying.

For example, if you have a good credit score and positive credit history, you’ll likely be offered better interest rates.

This means that the total amount you pay will be cheaper overall. Having poor credit history will usually mean higher interest rates, so you’ll pay more over time.

Shopping around for the best APR rates is a good way of saving some money.

This means that the interest on top of your monthly car payments will be lower, and you’ll pay less overall.

You can also get a good car finance deal by looking for deposit contribution schemes that will grant you money towards your contribution.

The dealer will offer a deposit towards your car to make the overall payments more affordable.

Choosing a longer contract can make your monthly payments lower, and borrowing less overall will, of course, keep costs low, but this will likely mean higher interest rates and cost more overall.

You can also offer a larger deposit to minimise your borrowing and your repayments as a result.

Car finance and credit scores

One of the best ways to get a better car finance deal is to ensure you have a good credit history.

You build credit history over time by paying off debts and keeping on top of payments.

You’re more likely to be accepted for better APR rates on your car finance deal if you have a good credit score.

In fact, paying your car finance on time is a great way to improve your credit score.

Missing car finance payments can have the opposite effect and will cause your credit score to drop.

You might also find that your credit score drops initially after applying for car finance, but this shouldn’t be permanent if you keep on top of payments.

As well, having too many credit checks on your credit history can also have a negative impact.

Lenders will carry out hard and soft credit checks when you apply for finance – hard will show up on your report and be noticeable to other lenders, while soft checks will not.

Too many hard credit checks can put lenders off, so be careful with how many times you apply.

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Can I end my car finance contract early?

You are usually able to pay off your HP or PCP car finance early if you want to, or you can choose to voluntarily terminate your contract.

With HP and PCP, you’ll have the option of voluntary termination if you’ve paid more than 50% of your finance agreement.

At this point, you can hand back the car and pay for nothing more.

If you want to keep your car, you’ll need to contact your car finance provider for the settlement fee.

Once you’ve paid this, you’ll be the legal owner of your car and will not need to pay anything else.

Settling car finance

If you want to pay the outstanding finance on your car and settle early, you’ll need to pay the current settlement fee on your account.

This changes with every payment you make, so make sure you have the most up-to-date figure.

You might want to settle car finance early if you don’t need the car anymore and want to sell it or part-exchange, or think it’ll be cheaper to pay early and avoid accumulating interest fees.

Depending on how much you’ve paid off, it might be worth checking with your lender how much is left to pay.

It could be more beneficial to pay off the rest of the balance and keep the vehicle than it would be to return the car.

Can I sell a car on finance?

Whether or not you can sell a car that’s on finance will depend on the type of finance you have.

With PCP and HP finance, you won’t be the legal owner of your car until you’ve paid the full balance of your finance agreement.

This can be through your normal monthly payments, or by settling early.

If you have a car that’s purchased with a personal loan, you can sell the car before you’ve paid the outstanding balance. This is because you’re the legal owner of the vehicle.

You cannot sell a car with outstanding finance as you don’t own the vehicle and it’s not your property to sell.

It’s important to settle the full balance of your HP or PCP car finance before you sell.

Learn more about car finance:

• Buying a used car on finance

• What's the best way to finance a new car?