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What is car finance?

Almost everyone in the UK needs to be able to travel from one place to another: whether it’s from home to work, to the supermarket or even just to a friend’s house for coffee, we all use some mode of transport. While some people are able to get everywhere they need to by public transport (usually people in inner cities as the transport links are much better), others choose to travel by car. While driving is convenient, it’s not always cheap and buying a car outright is not usually something just anyone can do. It involves a lot of saving, which is fine if you have the time to save, but if you need a car now and you don’t have any assets to sell, then you might be looking to finance a car instead.

What is car finance?

Simply, car finance is a way of spreading the cost of purchasing a car over a few years so that you can manage the repayments without dismissing your normal financial commitments.

Types of car finance

There are several different types of car finance and the ones you have probably heard of include hire purchase (HP), personal contract purchase (PCP) or even just a personal loan for the purposes of purchasing a car.

Hire Purchase

Hire purchase agreements sort of act like a mortgage in that you make regular payments each month for a set period and, at the end of the loan period, you become the owner of the asset. You will pay interest on the total amount borrowed from the creditor and you normally have to put a deposit down, so it will cost more than buying the car outright. However you will become the owner of the vehicle at the end of the agreement which makes this type of car finance more attractive than leasing a car with a personal contract purchase (PCP).

Additionally, there is what’s known as the half-rule and the third-rule with HP agreements. If you have paid over half of the total amount due, you have the right to hand the asset back with no further liability: in other words, you can terminate your agreement early if you have paid at least half of the amount due. The third-rule means that the car cannot be repossessed without a court order if you fail to make your agreed repayments once you have paid over a third of the total amount due.

Personal Contract Purchase

Like a hire purchase agreement, a personal contract purchase agreement means you make monthly repayments to the car financer, however unlike a hire purchase agreement, you don’t own the car at the end of the loan term. This is because a PCP agreement is a form of leasing – you have access to the car during the agreement, but in order to become the owner of the vehicle, you usually have to pay what is known as a balloon payment. This is an additional (and usually quite large payment) at the end of the contract.

PCP agreements might work for you if you intend to change your car every 3 or 5 years, however it’s important to remember that you never own the vehicle, and so if you miss your repayments or fall behind, the vehicle can be repossessed.

Because you won’t own the car while leasing it, you won’t acquire it as a financial asset so it’s not seen as an investment, like a hire purchase or a personal loan might. Although cars tend to depreciate over time (lose value), by owning the vehicle, you will still have a financial asset you could sell if the occasion arises. Additionally, if you do want to keep the car at the end of the agreement, a PCP is generally more expensive than a hire purchase agreement.

Personal Loans

A personal loan is a much more general type of finance and it’s not just for financing vehicles. Personal loans might be used to help with a mortgage deposit, house renovations or even to pay for a wedding.

Benefits of using a personal loan to buy a car include owning the car immediately; while you are borrowing money, you are not borrowing from the dealer and so once the money is transferred, you become the owner of the car. Personal loans often have loan terms of up to seven years, although the longer the agreement, the more you will pay in interest so it’s a good idea to work out how much you can realistically afford each month, just in case a few budget cuts here and there can save you hundreds or even thousands of pounds in the long run.

Personal loans also tend to have low interest rates, but that means they are usually only available to people with a good or even excellent credit history, so it isn’t an option for everyone. Plus, as cars depreciate over time, you won’t be able to sell the car for the same amount that you bought it for, which is why personal loans are probably better used to buy second hand or used cars, rather than brand new ones, as second hand cars tend to lose value less quickly than new cars.

Where is car finance offered?

Normally, you will be offered or advised about car finance options when you confirm to the sales assistant that you intend to purchase a car. It’s important to be aware that some car salesmen will get a commission if you take out finance with their associated lender, so they might promote it over other forms of car finance, although they should tell you if this is the case. You will need to establish how you intend to pay for the car and whether you plan on keeping the car at the end of the loan term as this will affect which type of car finance applies in your circumstances.

If you have decided to purchase a car with a personal loan, you are effectively a cash buyer and so you might in fact be able to haggle the price of the car down – it might seem daunting but it will be worth it, even if you only save a few hundred pounds as you could put the savings towards the car insurance, MOT or car tax, for example. If you buy a car from a dealership, usually it will have recently been MOT-ed, but it’s worth asking what other extras you can get, such as 3 years free servicing or extended warranties for example.

Should I finance a car?

Ultimately, buying a vehicle at any price is a big commitment and so you need to be sure you are in a financially stable position to do so. If you have a disposable income of £300 per month, there is no use taking out car finance at £300 per month as you will have no room in your budget for emergency expenses or even just little luxuries like days out and nice dinners. Like buying a house, purchasing a car comes with additional fees like servicing, insurance, car tax etc, and different cars will cost different amounts to run, so make sure you do your research and get an insurance quote prior to signing on the dotted line, as there’s no use buying a car if you can’t afford to insure yourself to drive it.

As with any loan agreement, missing your repayments can cause serious money problems and make credit harder to obtain in the future, so don’t over commit your finances, and try to save up beforehand where possible to reduce the amount you need to borrow and therefore reduce the amount of interest you pay.

More information

Five reasons you should start saving

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