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More people than ever are choosing to finance their next car purchase. The cost-of-living crisis has affected many people’s financial situation and used car prices are higher than they were pre-covid, this means that not many people can afford to buy a car with cash anymore. It can be hard to find the money to finance a car too but for many drivers their car is a lifeline to their livelihood. The blog below has been designed to explore how car finance works and if it could be suited to your circumstances.
How does car finance work?
Car finance is a legal agreement which allows you to borrow money or borrow the value of a vehicle from a lender. You then make monthly payments till the end of the finance term. You can choose how long you finance the car over but usually car finance agreements last between 3-5 years. Some agreements also require a deposit at the start of the deal but there are also many options with no deposit to pay, however, it’s always worth checking before you sign on the dotted line. In the UK, there are three main types of car finance agreements that tend to be the most popular, they are a personal loan option, hire purchase agreement and PCP car finance.
Personal Contract Purchase
A personal contract purchase deal is one of the most flexible forms of car finance. Instead of covering the cost of the car, you cover the cost of depreciation which helps to make monthly payments lower. However, if you want to own the car, there is a large balloon payment to pay at the end which most drivers can’t afford. Alternatively, you could also hand the car back to the dealer or use any positive equity in the deal to get a newer car on PCP.
Hire purchase is one of the most straightforward forms of car finance. You take out a loan from a lender which values the cost of your chosen car and make monthly payments with interest till the end of the term. Monthly payments can be higher than PCP deals, but it means once the deal has ended, you are the automatic owner of the car and there are no more payments to make. HP can be good for bad credit applicants as the lender owns the car throughout and if you fail to pay, they can take the car off you.
A personal loan option is when you borrow money from a lender to fund whatever you like. Your requested set amount you need and if accepted, have the money deposited straight into your bank account then you can buy a car just like a cash buyer. You then make monthly payments till the end of the agreed term. Personal loans can be one of the best low interest rate car finance deals around as they are usually reserved for those with good credit scores.
What to consider before taking out car finance:
- Credit score
Your credit score is an important factor when it comes to car finance. Lenders use a credit check to see how you’ve handled credit in the past and the likelihood of you paying your loan back on time. A low or bad credit score usually indicates you’ve had trouble making payments on time in the past, have no previous borrowing history or have high levels of debt. Lenders can also reserve the best rates for those with better credit scores so it can be worth improving your credit before you start applying.
- Monthly repayments
Car finance is a legal agreement which means it’s really important that you know you can meet your car finance payments on time and in full. If not, it can lead to more serious financial implications and affect your ability to borrow in the future. If you’re not sure how much you can afford, you can use a free car finance calculator UK to work out how much you can afford and based on your credit score what kind of loan amount you would be looking at.
- Interest rates
It can be possible to get car finance with 0% interest, but this is usually on brand new cars which aren’t accessible to everyone. Interest rates reflect the cost of borrowing and factors such as a bad credit score and the value of the car you choose can affect your interest rate. A higher interest rate means you pay back more overall and choosing the wrong deal can make car finance more expensive than it needs to be. You should try to shop around for the lowest interest rate to help make car finance payments more manageable and affordable.
- Ownership of the car
For many drivers, whether they own the car at the end of the deal or not is a big selling point. It’s with exploring each car finance agreement above in more detail as they all have different ownership options. For example, a personal loan lets you buy the car outright which means you are the owner from the offset and can sell the car when you like and modify it as you wish. HP and PCP are forms of secured loans which means the lender owns the car throughout the terms. However, both agreements allow you to own the car at the end if you wish. It’s worth noting though that there is a large balloon payment to pay at the end of a PCP deal which many drivers can’t afford.