Compare car finance vs personal loans

So, you've got your mind set on a car and you're ready to drive to your next adventure. But first, you need to figure out the best way of buying it: car finance or personal loan?

Choosing between a car loan and a personal loan can be tricky because they’re both suitable options with different pros and cons. Things are complicated further by the multiple types of car loans that exist.

In order to come to the most sensible decision, the trick is asking yourself the right questions. Luckily, we can help with that.

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Car finance vs personal loan

While a personal loan is a pretty straightforward financial product (you borrow money, you pay it back with interest in an agreed number of monthly instalments, and that’s pretty much it), car loans are a bit more complicated. We’ve tried to nail down the main differences between these two.

Car finance

There are essentially two types of car finance: you can purchase your car on personal contract purchase (PCP), which entails borrowing less money and making lower monthly payments but also making a pretty substantial balloon payment at the end, or on hire purchase (HP). With HP, you pay an initial deposit and then borrow the remaining value of the car, which you’ll pay back in instalments.

Despite some pretty substantial differences, about which you can learn more on our car finance page, HP and PCP share some basic features:

  • Secured against your car. If you don’t keep up with the payments, your car may be repossessed.
  • Will require a deposit. It can be as small as 10% of the value of the car, but you will need to have some savings if you want to purchase your vehicle through a car loan.
  • You won’t own the car right away. With both PCP and HP, you become the owner of the car only when you’ve paid off the whole debt. On one hand, this means it may be slightly easier to walk away if for some reason you don’t want the car anymore. On the other, you need to make sure you keep it in good condition, and if you’re on PCP there will usually be restrictions on how many miles you can make with the car.

Personal loan

With a personal loan, you’ll borrow all or part of the value of the car and pay it back monthly. The conditions will depend on your individual circumstances, but the loan will usually have the following features:

  • Unsecured. Which means you’re not putting your car on the line, but also that you may need a better credit score to qualify.
  • Lower APR (but not necessarily lower overall cost). Personal loans are typically offered on a cheaper rate than HPs or PCPs, but since a deposit isn’t required, you may end up borrowing more than with a car loan. So, even if the rate is lower, you may still pay more in interest.
  • Allows more freedom. With a personal loan, the decision on how much you want to borrow is entirely up to you, from the whole value of the car to just the final fraction of it that your savings can’t cover. Also, you can use the money on something else as well if you need to. Finally, you’ll own the car right away, so there are no mileage restrictions and you can even resell it to pay off the loan if you need to (or if your circumstances change and you want to change the car).

How do I decide between a personal loan and car finance?

Try asking yourself the following questions:

  • Can you afford the deposit? If you don’t have a deposit, this decision is a no brainer: only a personal loan will allow you to borrow the whole value of the car.
  • Are you expecting your circumstances to change? If, say, you’re starting a family and you think you may need a bigger car in the next couple of years, or if you fear your income may decrease, a personal loan is probably a safer choice. Getting out of a car finance deal is more complicated and you may end up losing money, whereas with a personal loan you can resell the car pretty easily because it already belongs to you.
  • Are you expecting to use the car way more than the average? If that’s the case, you probably want to avoid buying on PCP.
  • Do you have bad credit? If your credit score isn’t ideal, you should still compare the two options, but a car loan may end up being cheaper because the car acts as collateral. Without a good credit score, you’ll probably be offered a pretty exorbitant rate on unsecured personal loans.
  • How much can you afford to pay a month? If you need to keep the monthly payments as low as possible, a PCP deal is usually the way to go. However, keep in mind that you still need to save for the final balloon payment in order to buy the car.
  • How much is it going to cost overall? If none of the above questions points you to the right direction, it ultimately all comes down to price, or more specifically, to how much you’ll end up paying in interest. Get quotes for all the options, ignore the rates for a second and just calculate which is going to cost you the least.

The bottom line

A personal loan grants you more flexibility and allows you to own the car the moment you purchase it. However, it’ll only be cheaper if you have good credit, don’t borrow too much and can afford fairly costly monthly payments.

On the other hand, buying on PCP can be sensible if you’re not sure you want to keep the car in the end and want to keep the monthly repayments as low as possible. Finally, HP deals are a sort of middle ground between the two.

A good way of going around it is budgeting how much you want your monthly payments to be, and then working your way back to figure out which finance option will offer the best deal with that amount.

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