For the vast majority, buying a car means having to rely on some kind of finance. The simple maths of an item costing several thousand pounds means that most people don’t have the full amount to simply pay cash for their new motor. And even those who do will often have better uses for that money.
At that point, then, how do you decide which type of finance is best for you and your car purchase? And here we’ll look at the main types; personal loans, hire purchase (HP), personal contract purchase (PCP), leasing or personal contract hire (PCH) and subscriptions or car rental.
Before determining which is best, though, we also need to look at affordability and credit status.
Affordability
Both you and, if you are borrowing money, your lender should assess affordability carefully. Be sure you evaluate your income versus outgoings, not forgetting that the car will carry regular costs; insurance, road fund licence, fuel, servicing and tyres – always assess these factors for the specific vehicle you are considering.
Once you’ve worked these out, then there is the cost of borrowing to consider.
Finance guides will commonly point you to seek out the lowest interest APR. Crucial though this is, always be mindful that the ‘representative APR’ advertised by a lender may not be the rate that will be available to you. It is all to do with your credit status and sometimes on the amount of money to be borrowed. This is why there has been a rise in the number of adverts from companies helping to track and improve your credit score.
Credit score
Lenders will invariably assess every applicant's ‘credit status’, which will depend upon your credit history and other details such as employment and residential status.
In short, someone with a good credit history, secure long-term employment record and who has lived at an address they have owned for many years is likely to be highly creditworthy and is more likely to get the lowest APR, with interest rates likely to increase for less creditworthy people. This is all down to a lending approach called ‘risk-based pricing’.
A number of companies allow people to check their credit status online (always look for one that provides a 'soft search' that does not leave a recorded search on your credit file). Such searches are not guaranteed but can provide an indication of the type of interest rate you might expect.
Personal Loan
Available from a bank, building society or finance provider, unsecured personal loans tend to target the most creditworthy and acceptance rates are generally understood to be lower than for other lending firms. The interest rate is fixed for the duration of the agreement.
You can spread the cost between one and seven years typically but always try to match your loan to the time you aim to keep the car. Not doing so can be a false economy.
Loans can be secured or unsecured; securing your loan against your home can place your home at risk if you fail to keep up with repayments.
From Day 1, you own the car, if that is important, but you won't get the additional consumer protection afforded under HP and PCP finance.
Hire purchase or HP
Available from the dealer supplying the car and specialist brokers, the finance is provided typically by specialist lenders that include finance divisions of carmakers. Lenders use the vehicle as security which means acceptance rates are often higher than personal loans. Dealers will sometimes offer special interest rates on new cars; the rates being subsidised by the carmaker.
You can spread the cost of your car by paying fixed monthly instalments with terms available from 12 to 60 months and an optional deposit amount. Where risk-based pricing is common in personal loans, it is only just emerging in HP.
Specialist lender MotoNovo Finance has developed a risk-based approach that has broadened the appeal of finance from its dealers. The rate set at the outset of the agreement is fixed.
When you have paid off the finance agreement and the option to purchase fee, the vehicle becomes yours. HP carries Section 75 consumer protection under the Consumer Credit Act, so if there is a problem with the car, the lender may be able to help.
Personal contract purchase or PCP
A derivative of HP, this product contains a balloon payment or, more accurately, guaranteed future value (GFV) at the end of the finance agreement, which would make the monthly instalment amounts lower than a traditional hire purchase (HP) agreement. The GFV and terms and conditions are dependent upon an annual mileage agreed at the outset of the agreement.
When you have paid off the finance agreement, as well as the GFV, the vehicle becomes yours.
Alternatively, you can return the vehicle to the lender or use it as a part exchange against your next vehicle.
Interest rates are fixed at the outset of the agreement, and bear in mind APRs can be higher than a similar HP agreement because the GFV means you are borrowing more money.
Be aware there may be some additional charges if you have exceeded the mileage limit set out in your agreement or if damage to the vehicle has occurred.
Personal contract hire or PCH
In essence, a PCH finance agreement is a long-term rental or lease plan for a new or nearly new car for a fixed period, so you will never own the car – or ever have the option to buy it.
Instead, you'll pay an initial deposit followed by a monthly amount for the duration of the contract, which is usually over one to four years that includes VAT.
PCH agreements may cover items such as road fund licence and servicing but you’ll need to check. You will not see an APR because leasing is not covered by consumer credit legislation.
As with PCP, you'll need to choose a mileage allowance (e.g. 8,000 miles a year), and you're responsible for its upkeep. At the end of the agreement, you just hand the car back, although you could be charged if you've exceeded the mileage or damaged the car.
It is important to note, you are tied in for the entire duration of the agreement, and there may be significant charges if you need to change or stop the contract.
Subscription
Some lenders have sought to develop a more flexible leasing option that allows you to change your car more often or for a shorter period. In essence, a shortish term rental agreement, the emerging subscription options offer flexibility as a price (again, like PCH, no APRs are available). If you like to change your car with the seasons, this could be an interesting option. However, prices are often higher than a regular lease or PCH agreement.
Keyword: Which type of car finance is right for you?