What Are The Four Main Types Of Car Finance?

Car Finance

A brand new car can cost upwards of twenty or thirty thousand pounds. For most of us, this is an impossible amount to fork out in one big flourish. Whether you need a stylish two-seater or a people carrier for a family of five, buying a car outright can be tricky. 

Using a finance option is the best and safest way to buy a car by spreading out payments over a more extended period. But there are a few factors to think about before you commit. 

The four main types of car finance explained

Many car finance options exist to meet different repayment needs. Let’s look at the four main options.

Personal Loan

Personal loans allow you to get all the money to buy a car in full. Your repayments occur over an agreed period of months or years, often at a fixed interest rate. 

There is no need to put up an asset like your house as security, as personal loans are unsecured. This consequence is a plus, as it means that your belongings do not become vulnerable to repossession by the bank issuing the loan. The downside is that you’ll need a strong credit rating because the risk is low for you and high for the bank.

Checking your credit rating to see what loans you’re likely to be approved for can be done for free on websites like experian or at an alternative like credit karma. There are also bad credit car loans available from specialist lenders.

Hire Purchase (HP)

For a hire purchase, you place a deposit before driving away your new car. Next, you will make regular repayments without actually owning the vehicle. You are also not allowed to sell the car until you have completed the final payment, as well as the extra ‘option to buy’ fee, which lenders commonly set around £100-£200.

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A hire purchase differs from a personal loan, where you own the car immediately. One of the rules of hire purchase is that the lender secures the loan against the car itself. If you miss payments, the lender will claim the car. 

Also remember that if you end the hire purchase agreement early, you will often incur a fee. 

Personal Contract Purchase (PCP)

PCP is one of the most popular forms of lending to buy a new car. However, it is more complicated than other lending options. 

When you enter a PCP agreement, you don’t fully own the car but place a non-refundable deposit and borrow the remaining amount. Next, you make monthly interest and depreciation payments (wear and tear that leads to reduced value over time).

When the contract ends, you have a few different options:

  • Buy the car in full 
  • Trade the car for a different model with a new PCP contract
  • Return the car

Note that buying the car involves paying the remaining amount, less the deposit. 

PCP loans are perfect for those who like a new car every year. One of the most significant advantages is that they are flexible and involve smaller monthly payments. This detail is because you never pay off the entire car value. 

However, there are drawbacks to PCPs. Interest is higher than other loan types, and you need to know that any damage or exceeding the agreed mileage will lead to penalty fees. 

Getting approved for a PCP is usually only possible if you have a strong credit rating. This rating detail is especially true for 0% or low APR contracts.

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Leasing a car is like a simplified version of PCP but without the option to buy. Similar arrangements exist for the agreed maximum mileage and the duration for which you will use it. 

When leasing a car, it is essential to read all of the small print, especially when it comes to ‘excessive wear and tear’. You will have to pay extra fees if the car is more damaged, however minor, at the end of the contract. 

Car lease companies do not cover insurance, so you need to insure the car as if it were your own using fully comprehensive cover. Funding your insurance means that you cover any damage costs. 

Some car leasing companies also have gap insurance as part of the agreement, giving the company more protection from theft or damage. 

Final points to remember

Buying a new car on finance can be practical in the short and long term. You can spread payments out and access a brand new car immediately. 

However, it is helpful to make considerations for any long-term investment. These can include extra penalty fees and costs not covered by the finance, such as maintenance and fuel. It is essential to research different finance plans and account for all the extra fees and how to avoid penalties.

You may miss payments without budgeting for all factors, which will negatively impact your credit score. And the lender may claim the car as payment. But with adequate research and detailed planning making payments on time, you can get your vehicle while enhancing your credit score.

When you do it the right way, car finance can be an ideal option for those wishing to own a new car without needing large amounts of money upfront.