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What is car finance?

Car finance, often referred to as vehicle financing, can be a convenient and flexible way for individuals to acquire a new or used car. It can allow borrowers to spread the cost of their vehicle over a set period, with various options such as personal contract purchase (PCP), hire purchase (HP), or car leasing, making it easier for people to access the car of their dreams while managing their budget effectively.

What types of finance are available?

The cheapest way to buy a car is to buy it outright without borrowing money. If you can save a regular amount and only make the purchase when you’ve built up enough money, then you won’t pay a penny in interest. Sometimes that’s not an option, however, in which case you can consider car finance. Car finance is the process of funding a vehicle purchase over a set period of time.

If however you do need to borrow in order to purchase your next car, then remember that in general terms, the more you borrow, and the longer the period over which you borrow it, the more you’ll end up paying in interest. If you can afford to, make part of the payment using your own money in order to reduce the amount you need to borrow.

If you aren’t buying a car outright with cash, then there are a few different ways to fund your purchase. Here are some popular options:

• Personal loan
• Credit card
• Hire purchase
• Personal contract purchase

A broker, such as Zuto, can quickly provide personalised quotes for different forms of vehicle finance based on your answers to a few simple questions.

Buying with a personal loan

Personal loans are available from a range of lenders – including banks, building societies and supermarkets. Personal loans are generally available over terms between one and seven years. Each lender will have its own interest rates, fee structures and amounts available. If you apply for a personal loan, the lender will look at factors like your income, expenditure and credit score when deciding whether or not to approve the loan. Once approved the funds are transferred to your account and you’re free to make your purchase.

Pros and cons

Buying with a credit card

If you’re approved for a credit limit that covers the purchase of the car you’re after, and you’ve compared credit cards to find a lengthy 0% on purchases deal, then using a credit card can be a smart way to buy a car. As an added bonus, credit card providers are obliged to give protection on credit card payments between £100 and £30,000.

The downside is that if you don’t pay off the debt within the 0% period, the rate is likely to revert to something far less competitive than a standard loan. Because you’re only obliged to make the minimum monthly payment, you’ll want to work out how much you need to pay each month in order to clear the debt before any offer period on the card expires. Additionally, if you’re worried you’d be tempted to make further purchases on the card, then this might not be the smartest option for you.

Pros and cons

Compare 0% purchase credit cards

Buying on hire purchase (HP)

If you opt for hire purchase, you’ll generally be expected to pay a minimum of 10% of the vehicle’s value upfront, and you’ll then pay the remainder off over one to five years. The credit is secured against the car, so if you fail to keep up repayments you stand to lose the car.

Hire purchase agreements are normally arranged by the dealership. This means they’re quick and easy to sort out. However it also means that they tend to be more competitive when you’re buying one of their new cars, as opposed to a used car.

Pros and cons

Buying using personal contract purchase (PCP)

With personal contract purchase (PCP) you essentially take out a loan for the difference between the current value of the car, and the projected value of the car at the end of an agreed period (generally one to four years). You’ll make monthly payments, and then at the end of the agreed period you can make a balloon payment to purchase the car outright.

PCP’s are arranged so that at the end of the agreed period, the car should be worth a little more than the balloon payment you would have to make to buy it outright. You can’t claim this back as cash and walk away, however – at the end of the agreed period you have three options:

• Make a one-off balloon payment to purchase the car outright.
  If you like the car and don’t want to switch, this could be a smart choice.
• Hand the car back and walk away.
  If you can’t afford the balloon payment, and you’re not keen to enter into a new PCP this is probably what you’d do. If the value of the car has decreased more than expected, and it’s actually worth less than the projected amount, then provided this isn’t due to damage or excess mileage, you’d generally hand the car back and walk away.
• Trade the car in and enter into a new personal contract purchase.
  This is a popular option if the car is worth more than the balloon payment you’d need to make to buy it outright. You can put this ‘equity’ towards a deposit on another PCP.

When you enter into a PCP, you’ll be asked what mileage you expect to clock up in the vehicle. It’s important to answer this honestly, otherwise, you’ll find yourself in a weaker position at the end of the PCP. Bear in mind that if you damage the car or exceed the agreed mileage limit there will be charges to pay at the end of the agreed period.

The credit is secured against the car, so if you fail to keep up repayments you stand to lose the car.

Pros and cons

What is a balloon payment?

A balloon payment is one large payment that’s due at the end of your loan following smaller monthly payments. In general, you may have the option of making a balloon payment in two cases:

• You’re purchasing your vehicle through a personal contract purchase (PCP). With a PCP, you borrow the difference between the current value of the car and the value it’ll have at the end of the agreement (which is usually 1-4 years later), minus the deposit. The “final” value of the car is generally referred to as the guaranteed minimum future value (GMFV). You pay off the loan in monthly instalments and at the end you can choose between purchasing the car through a balloon payment (whose value has been established at the beginning), giving it back and walking away or entering another PCP for a new car.
• You’re purchasing your vehicle through a lease purchase (LP). LPs are similar to PCPs, but the final balloon payment is mandatory and you have to purchase the vehicle at the end of the contract. LPs are generally used to purchase vehicles you plan to use a lot, such as business vans, because with PCPs there are normally penalties for damages and excess mileage. The drawback is obviously that you can’t opt out if the value of your vehicle suddenly decreases, or if you can’t afford the balloon payment.

What are the benefits of a balloon payment?

Although you may owe a large amount once your loan is up, balloon payments have their benefits which include:

• Reduce your monthly payments. This is the main advantage of a balloon payment schedule. You’re only paying off your interest so your monthly payments will stay small and more affordable.
• Build up your savings. You’ll know from the start how much your balloon payment will be. This means you can start saving for it as soon as your loan begins, earning interest on money that would otherwise be going into your lender’s pockets.
• Balloon payments are usually a bit lower than the car value. So they can make good value for money. Conversely though, the value of a car can also fall unexpectedly, and the amount of the payment can’t usually be renegotiated. If you’re in an LP and can’t opt out, you’ll end up paying more than the car is worth.

Are there drawbacks to a balloon payment?

While there are some benefits to having a balloon payment at the end of your car loan, consider some negative features before committing to a loan.

• It can lead to more debt. If you find yourself unable to save up for the final balloon payment, and are in an LP, you could be stuck refinancing your loan and taking on even more debt and paying more in interest.
• You won’t own the car until you make the balloon payment. If you take out a personal loan to purchase the car instead, it’ll be yours from the beginning.
• You can face damage and over-mileage charges if you go for a PCP.

How do I find the best car loan?

The best car loan for you will depend on your specific situation, but here are some of the important questions to ask before settling on a particular loan product.

• Am I eligible? There’s no point in applying for a loan if you don’t meet the lender’s minimum requirements. Find these requirements on the lender’s website or in online reviews.
• How much can I borrow? Does the lender offer loans that cover the total cost of a car you’re interested in — and can afford?
• Are the interest rates competitive? A high minimum advertised interest rate isn’t the best sign, and a refusal to disclose interest rates can be even worse. It could mean that rates are so high, that the lenders would rather not advertise them.
• What are the fees? On top of dealership and state fees associated with buying a car, some lenders charge fees for taking out a loan.
• How long are the loan terms? Does your lender offer terms you can afford after you factor in APR and other costs involved in getting a new car?
• What’s the deposit? A 10% deposit is standard, but some lenders charge more. Go for a lender that offers a deposit that fits your budget.
• What are the early-repayment terms? Paying your loan off early can save you money on interest. However many lenders will charge a fee, for example one month’s interest, if you wish to repay your loan early. With each of the finance options listed here, you should make sure to find out the early-repayment terms of the product that you’re considering.
• How’s its online reputation? Quickly scan online forums and review sites to see what people say about each lender. Are interest rates high? Do people have trouble making repayments? If anything sounds sneaky, run.
• What services does it offer? Some lenders hold your hand throughout the process of getting financing, and others don’t. Consider the help if you don’t know what you’re doing — but also ask: Is the lender genuinely helpful or just pushing you into your partners’ laps.

Can you get a car loan if you have bad credit?

Yes, it’s possible to get a car loan with a lower credit score, although it may be more challenging and come with higher interest rates. Some lenders who specialise in bad credit car loans may offer options for individuals with less-than-ideal credit, but it’s important to be prepared for stricter terms and conditions.

Finance options for first-time car buyers

If the bank of mum and dad is closed right now, here are some options to consider:

• An unsecured, fixed-rate personal loan. A personal loan is a very common method of financing a car purchase. They’re available from high-street banks and online lenders, and there are plenty of specialist lenders around that serve “non-standard” (read “bad or limited credit”) borrowers. If the loan has a “fixed rate”, it means that the interest rate won’t change during your loan, so you’ll know in advance exactly how much you’ll pay each month and overall.
• Hire purchase. With hire purchase you’ll need to put down a deposit (normally at least 10% of the vehicle’s value) and you’ll then pay the remainder off over one to five years. The credit is secured against the car, so if you fail to keep up repayments you stand to lose the vehicle. In fact, you won’t actually own the car until the final payment has been made. These deals are normally arranged by the dealership, which means that they tend to be more competitive when you’re buying one of their new cars, as opposed to privately buying a used car.
• Personal contract purchase (PCP). With personal contract purchase you make monthly payments, and then at the end of the agreed period either make a balloon payment to purchase the car outright or give the car back. Because of the balloon payment at the end, your monthly payments are lower than with hire purchase.
• A guarantor loan. With a guarantor loan, a friend or relative promises to step in and pay off your loan if you fail to do so. Interest rates on these loans aren’t fantastic, but sometimes they can be better than you’d get if you applied on your own.

You could even pay for your car using a credit card. It’s not quite as mad as it sounds, but that’s only if you have the self-discipline to use the card correctly and, crucially, if you can get approved for a long enough 0% purchase deal, with a high enough credit limit (which is likely to be extremely tricky if you don’t have much in the way of credit history).

Realistically, for most first-time buyers, a credit card won’t be a sensible or realistic approach to financing a vehicle purchase.

Tips for financing your first car

1. Don’t just accept dealer finance without comparing your options. Be wary of pushy car dealerships that want you to sign on the line there and then for their finance deals (which will naturally earn them a commission). Buying a car is a big move with long-term financial implications, so it’s important to shop around.
2. Get to know your credit score. There are numerous services that can offer you visibility of your credit score for free. To access your full report, you’ll normally have to pay a little each month. Once you know your score, you can look at ways of improving it.
3. Put down a large deposit (if you can). By reducing the amount you need to borrow, you’ll be less of a risk to lenders and the loan will cost you less.
4. Look at the overall cost of each option. A great rate is one thing, but once your loan has been spread over a number of years, or once the fees have been taken into consideration, that rate might not be giving you the full picture. Always look at the total cost of borrowing. Naturally you want to keep this as low as possible, while ensuring you can comfortably afford the repayments.
5. Use “eligibility checkers” or a “matching service”. These days, you don’t have to simply apply for a car loan and hope. Lenders offer “eligibility checkers” which can tell you your likelihood of getting approved before you apply, without affecting your credit score. What’s more, a good broker or matching service will be able to check your eligibility with a range of lenders in one go.
6. Consider applying with a guarantor. You might not have much in the way of credit history, but maybe a friend or relative who has excellent credit would be willing to act as your guarantor – helping you get your application across the line.

Frequently asked questions

• Why was my car loan application rejected?

  You can typically find out why your car loan application was denied by contacting the lender. If you applied online, you can often find out simply by logging in to your account. Otherwise, reach out to customer service over the phone to find out how to get this information.

  Some common reasons why car finance applications are denied include:

  • Affordability. Lenders must only lend responsibly. That means looking at your regular income and outgoings to see if there’s enough left over to comfortably cover repayments on the loan you’ve requested.
  • Credit history. Your credit record is used as an indication of how likely you are to pay back or default on a loan. It includes details like past CCJs, missed payments and previous credit searches. A higher credit score means a lower risk for lenders. You don’t have a single definitive credit score – different credit reference agencies (CRAs) calculate your score in different ways, but if you have a good credit score with one, you’ll almost certainly have a good credit score with others. It’s usually free and fairly straightforward to check your score.
  • Eligibility. Each lender has its own set of criteria that all borrowers must meet. You’ll invariably need to be over 18 and a UK resident, but there may also be an upper age limit or requirements on the vehicle that you wish to purchase. Make sure to check a lender’s eligibility criteria before you apply.
  • Employment. If you only just started a new job, if you’re self-employed or have an unstable employment situation, some lenders may consider you a higher risk.
  • Simple mistakes. You might be surprised how many car loan applications are rejected on a technicality. It’s possible you could have made a simple mistake on the form.

• How can I avoid getting my car loan denied again?

  If your car loan application is rejected, there are three simple steps to take before you apply again:

  • Ask why. Lenders typically explain why your loan was declined if you ask. This can give you an idea of what to do differently next time and whether the issue is a problem with your finances or the lender’s strict requirements.
  • Get prepared for next time. There may be measures you can take to boost your chances, like reducing debt, applying for a more affordable loan or working on your credit score.
  • Consider a broker/matching service. Enter your details just once, to get a good idea of the lenders that would be able to offer you a loan, all without hurting your credit score.

• Can you get a car loan without a credit check?

  No credit check car loans aren’t available. A credit check will always be required if you want a car loan.