Different Types of Car Finance Explained
It’s that time again, you’re on the market for a new vehicle. One with all the bells and whistles, you know, wheels, doors, maybe some sort of sport stripes, the works. Now the only thing left is to figure out how you’re going to fund the purchase of your new vehicle.
That’s where car finance comes in. Long story short, car finance is an option to spread the cost of your car across an extended period of time, meaning you don’t have to pay a lump sum all at once.
Our guide to the different types of car finance explained below is sure to help you on the road to acquiring the right finance for you - whichever route that may be.
What are the Different Types of Car Finance?
There are several different types of car finance you can choose, ranging from a personal loan to PCP. Each has its own pros and cons and it’s important to understand these before applying for any type of car finance.
When purchasing a new vehicle it’s important to budget accordingly and weigh up all your options.
The different options available are a personal car loan, hire purchase (or HP), personal contract purchase (or PCP), personal contract hire (or PCH) and car leasing. Some of these are a bit more difficult to break down than others, so we’ll explain each option in detail for you.
1) Personal Car Loan
What is a personal loan?
A personal car loan is exactly what it says on the tin, a personal loan for the purchase of your car. These can be provided by banks, building societies and even, peer to peer lenders.
A personal car loan (or unsecured loan as they’re more often referred to) is a type of car finance in which you borrow a considerable lump sum, usually £5,000+ and pay it back in fixed instalments over an agreed period of time.
This provides a flexible option of securing car finance, on your own terms. Choose how much you need to borrow and how much you’re prepared to pay a month. It’s really as simple as that.
Here’s an example of a personal loan:
You’re looking to purchase a Renault Captur Iconic which for the sake of convenience costs bang on £10,000.
You look for a personal car loan on the market and you find a loan with a fixed rate of 2.9% APR.
You have agreed to pay off your loan in a period of three years, meaning your monthly payments total £290.20 and your total amount payable comes to £10,447. In total, you have paid a total interest of £447.
Advantages of a personal loan
- These types of loans are not secure against any types of assets such as your home or car, meaning the car cannot be repossessed
- Some personal car loans offer next day or even same day funding
- Interests rates can often be lower than other car finance options, depending on your credit score can be below 3% APR
- Has the ability to improve your credit score over the duration of your contract
- As a cash buyer, you may be able to negotiate a better deal on your vehicle
- You can sell the vehicle at any time, provided you keep up with monthly repayments
- Payments are fixed for the entire duration of your contract, meaning you can budget ahead
Disadvantages of a personal loan
- If you have a poor credit history you’re more than likely to struggle to get accepted for finance
- Monthly repayments are often higher than other car finance options because you own the vehicle
- You have to manage insurance, tax, warranty, upkeep of the vehicle, whereas other car finance options may have some of these included
- The car’s value will depreciate over time and therefore your investment will be worth much less when it comes time to sell
- If you decided to sell the car you still need to pay off the loan
2) Hire Purchase (HP)
What is a hire purchase?
This is where it gets slightly more complicated, as the lines start to blur between the different types of car finance. Essentially, hire purchase (or HP) works for all-intensive purposes the same as a personal car loan.
The only difference is that, unlike personal car loans, with hire purchase the loan is secured against the car. Therefore you don’t own the car until the last payment is made.
In most situations, a deposit is required which is usually equal to roughly 10% of the cost of the vehicle.
The rest of the value of the car is then paid over the duration of the contract, which can be anywhere between a year or five. The interest rate can vary depending on whether you’re looking at a brand new or pre-owned car.
Here’s an example of hire purchase:
So this time we’re looking at a Fiat 500, which again for the sake of simplicity costs £3,510.
You’ve found a hire purchase deal with a fixed rate of interest of 6.71% p.a, with an APR of 12.9% APR.
You have agreed to pay off the car purchase in a period of two years, meaning your monthly payments total is £148.95 and your total amount payable after your cash deposit of 10% (£350.93) is £3,926.73. In total, you have paid £416.73 in interest.
Advantages of hire purchase
- Unlike the likes of PCH and PCP, there are no mileage limitations
- Hire purchase provides the opportunity to build your credit score through making monthly repayments
- Unlike PCP, no large balloon payment is required to purchase the vehicle, payments are spread across a period of a few years
- Payments are fixed over the duration of your contract, meaning you can budget more effectively
Disadvantages of hire purchase
- The loan is secured against the car, so if you don’t keep up with the repayments they can take the car off you
- You don’t own the car until the final payment has been made
- Usually, hire purchase is provided by car dealerships so you’re more limited in terms of options
- Deposits are often required and usually higher than other types of car finance
- Monthly repayments are usually higher for hire purchase agreements than other different types of car finance
3) Personal Contract Purchase (PCP)
What is PCP?
Personal contract purchase (or PCP), is essentially a car loan but with a notable twist. You won’t be paying off the full value of the car, in fact, you won’t own the car.
There is a sizable chunk that is left out of the monthly payments, this is called the ‘balloon payment’ and is the excess that you will need to pay at the end of the agreement if you’d like to keep the car. If not, just hand the keys back and be on your merry way.
Again with PCP, they will be looking for a deposit (usually 10% of the value of the car). The more of a deposit you can put down, the less you will have to borrow and pay in both the monthly instalments and the balloon payment - if you decide you want to keep the car.
Unsurprisingly due to the simplicity and not paying the full value of the car straight away, PCP is one of the most popular types of car finance.
Here’s an example of a personal contract purchase:
Imagine you’re on the market for a Hyundai Kona. This particular vehicle happens to cost £15,000. The leasing company works out that the car will be worth at least £6,000 after three years.
You are required to pay a 10% deposit, so £1,500. You will then need a loan for the rest, which minus the deposit comes to £13,500. However, due to the vehicle being worth £6,000 after the three years, we can take that away from the total, leaving £7,500.
Then you’d be looking at paying the £7,500 over the three year period, on top of the interest which is over the total cost of the car minus the deposit, so £13,500. Which for the sake of simplicity let’s say is 5% APR fixed over the three year period.
So you’re paying £7,500 plus the £675 in interest which totals £8,175. Which means you’d be paying £227 a month. Leaving the ability to own the car at the end by paying the £6,000 balloon payment.
Advantages of PCP
- Provides flexibility and allows you to re-evaluate your financial situation when the time comes to make the balloon payment
- Monthly payments tend to be slightly lower due to not paying for the entirety of the car
- More than often services and MOTs are thrown in with the deal, along with insurance (doesn’t apply to all lenders)
- A PCP deal could see you driving a vehicle that you ordinarily wouldn’t be able to afford
Disadvantages of PCP
- You won’t own the car at the end of the agreement unless you pay the balloon payment
- There is a mileage charge so you could be billed additionally if you go over the agreed amount
- You will have to pay for any damage made to the vehicle, anything that isn’t normal wear and tear
- Interests rates are usually higher than other types of car finance
4) Car Leasing / Personal Contract Hire (PCH)
Car leasing explained
Car leasing is one of the most popular types of car finance alongside the likes of PCP. Usually, with car leasing you pay a deposit at the beginning, which is equivalent to several monthly payments, followed by a fixed payment each month.
With car leasing finance options you are generally looking at 12, 24, 36 or 48-month contracts, while some lenders can be more flexible these are the standard terms.
The key difference here is that you do not own the vehicle at any part of the contract, you are simply renting for an extended period of time. When you’ve made your last payment you can hand back the keys and walk away. It’s as simple as that.
Car leasing has numerous benefits which surpass simply offering convenience and affordability, even available for those with bad credit.
Here’s an example of car leasing:
You are looking to buy a Vauxhall Corsa. Your lender has asked you to pay a deposit of 6 months upfront, and the rest of the payments can be made across a 48-month contract.
Your monthly payments consist of £185 and your initial deposit totals £1,110. This means you have paid a total of £10,000 across a 2 year period, including the initial deposit.
Advantages of Car Leasing
- Since you don’t own the car you don’t have to worry about depreciation
- By making regular repayments consistently you can build your credit score
- Often the ability to rent provides an opportunity to drive a car that would normally be outside of your price range
- Car leasing makes for a simple and less confusing car finance option
- Servicing, warranty and insurance are usually tied in with monthly payments
- You have the freedom to swap and change cars when your contract is up
Disadvantages of car leasing
- Deposits can be higher than other types of car finance
- Generally requires good credit
- You do not own the vehicle
What to Consider Before Applying for Car Finance
There are seemingly endless things to consider when looking at the different types of car finance, even when you’ve chosen the one you’d like to go for. As much as it can seem like it, car finance isn’t as complicated as it’s made out to be.
We’re going to go through some commonly asked questions regarding car finance to ensure you can not only talk the talk but also walk the walk.
Is it hard to get accepted for car finance?
This begs the question, does car leasing require a good credit score? Does PCP require a good credit score? Does… you get the idea. More than not, you will need a good credit score to be accepted for car finance.
While major lenders often look for ‘good’ or ‘excellent’, it doesn’t mean you’re completely out of options if you’re verging on the side of bad.
What checks are done for car finance?
When applying for car finance there is usually a list of things that you’d need to provide as standard:
- Driving license/proof of identity
- Proof of income (3 months of bank statements or payslips)
- Address history
- Employment details and history
On top of these, possibly one of the most important things lenders will check is your ability to make repayments reliably through reviewing your credit report.
This is where a good credit score can come in handy to ensure no bumps in the road.
What happens if I’m rejected for car finance?
In the unlikely event that you are rejected for car finance, it’s not over. There are a few things you can do to carry on the search for your new car.
First of all, if the rejection has left you scratching your head. Wracking your brain trying to figure out why exactly you’ve been rejected - you can go online and have a look at your credit score report.
This should break down your score, the bracket you’re in, your payment history and what you can do to improve. If after studying your report there are some inaccuracies, you’re able to submit amendments to your credit report and get these updated.
Subsequently putting you in a position where you can appeal the decision and fingers crossed, get accepted this time.
If everything is 100% up-to-date on your credit report, then there’s only one thing left to do. Improve your credit score.
How can I improve my credit score?
Improving your credit score is by no means an overnight activity, you’re very much playing the long game aiming to be as consistent as humanly possible.
With that being said, there are a few things you can do to improve your bad or very poor credit score that may be holding you back, resulting in some possible quick wins.
- Make payments in full and on time
- Pay off any debt you may have (use your savings if possible)
- Improve your credit habits
Another question that we get a lot is, how long does it take to improve my credit score? Is there a quick way to boost my credit score? While there are no sure-fire ways to see your credit score shoot up dramatically overnight, there may be a couple of things holding you back.
- Check your credit score regularly and amend any inaccuracies
- Add rent and utility bills to your credit report
- Request a credit limit increase
- Consider different types of credit
- Pay down balances as much as possible
Improving your credit score is very much a full-time job, but as with all jobs, it becomes easier and more manageable with time.
Do you have a part exchange?
Part exchange can see you with cheaper monthly payments or a lower initial deposit, which can only be a good thing right? If you have an old car there’s no reason not to put it against your new car to make future payments smaller.
In fact, even if you have outstanding finance on any old vehicles you can still part exchange. It all depends on whether the amount owed on the vehicle is more or less than its worth, leaving you with either positive or negative equity.
Different dealerships have different processes and will either accept or deny part exchanges with outstanding finance, so you may need to ask them directly for a definitive answer.
Can you afford monthly payments?
This is the most important question you could ask yourself when looking at car finance. Depending on the different types of car finance you’re looking at can depend on the amount of financial strain this can put on you.
Whether you’re looking at PCP, car leasing, hire purchase or PCH it’s important to thoroughly access your finances.
- Can you see your income decreasing in the future?
- Do you have any outstanding debt?
- Do you have a stable income?
- Do you have any other financial obligations?
- Do you have savings?
Certainly, if you have any type of outstanding debt it’s a good idea to clear this down before applying for any type of finance. If possible, it can be worth using savings to settle any debts.
It’s not just monthly repayments that need to be considered, a car is accompanied by several other incurring costs such as tax, services, insurance etc.
While some PCP and car leasing options can manage some of these for you, the majority of the time these are your responsibility.
Affordable Car Finance for Poor Credit History
Pendle Leasing provides simple and affordable car leasing. If you have a poor or non-existent credit history, we provide a car leasing model that is based on affordability, not your credit score.
With the benefits of improving your credit score, driving a brand-new car and saving money, you’ll wonder why you never considered car leasing with Pendle Leasing before!
If this has left you screaming ‘sign me up!’ and you’d like to find out more. Simply contact us here to speak to one of our personal advisors.
If you’re curious as to what cars we have available, you can browse our range of car leasing special offers. From a selection of premium brands such as Ford, BMW, and Renault, we’re confident we have a set of wheels that’ll catch your eye.
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