A Guide to Car Finance: What You Need to Know

‍Motor finance is one way that many people choose to buy their car. It's important to understand the different types of car finance that are available so that you can make the right decision and choose the best option suited to your needs.

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When choosing a vehicle, it is essential to make sure that you can not only afford the monthly payments throughout the entire finance agreement term but also the associated vehicle maintenance and running costs.  

The total amount that you pay for buying your car on finance depends on whether you pay a deposit (including the amount you choose to pay), the finance term, and any charges applied by the finance company. If you put down a deposit, your monthly payments will be lower. If you choose a longer term, you’ll end up paying more in interest charges.

The best way to consider the terms being offered to you on any car finance agreement is to read the finance illustration. This is usually found in the Pre-Contract Disclosure and Adequate Explanation document issued with all regulated finance agreements.

Car finance offers are only valid for a set period, and the expiry date can vary from lender to lender. If the offer expires, you’ll need to reapply and understand that the lender conditions on your application may change, or in some instances, even be declined. It may also be helpful to read through Vision Funding’s blog on Understanding APRs to help you fully understand the information being offered to you.

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What Are the Different Motor Finance Offers Available?

Here are a few finance options that you may come across:

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Hire Purchase (HP)

An HP purchase gives you the option to own the car at the end of the agreement. These are normally at a fixed cost, meaning that the APR (Annual Percentage Rate) is set before the contract with the lender begins. The loan period (term) is also fixed, typically three to five years, and the HP agreement is secured against the car you are buying. This means that the lender owns the vehicle until you have made all the payments due. If you fail to make the repayments, they may have the right to repossess your vehicle.

Things to consider:

• In an HP agreement, you don't legally own the car until you make the final payment which will also include an ‘Option to Purchase’ fee. This fee is charged by lenders for transferring the title of ownership of the car into your name and amount charged can vary. You do have the option not to pay this fee and hand the vehicle back to the finance company.
• As the registered keeper, you are responsible for things such as DVLA Vehicle Tax, insurance, servicing, and maintenance. However, since you do not own the car until all the payments have been made, you cannot sell or modify it without the lender’s permission.

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Conditional Sale (CS) Agreement

A Conditional Sale agreement is the same as Hire Purchase, except that you will automatically own the car once the finance has been repaid in full; there is no ‘Option to Purchase’ fee.

Advantages of Hire Purchase/Conditional Sale:

• Finance offers are quick and easy to arrange and are available from most car dealerships.
• Both agreements are regulated, which means you will have rights and protections under law.
• You may not need a deposit, or only need a low deposit, at the start of the agreement.
• Choice of payment terms of between 12 and 60 months, although some companies also offer up to 84 months.
• Repayments are fixed at the same amount each month throughout the agreement.

Both Hire Purchase and Conditional Sale Agreements are ideal if you are looking for a straightforward car finance agreement with the option to eventually own the car.

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Personal Contract Purchase (PCP)

PCP is another popular way to buy a car using motor finance and is ideal for people who want lower monthly repayments and those who prefer to change their car on a regular basis.

It works similarly to other loans or car finance options like Hire Purchase, but there some important differences.

Taking out a PCP loan enables you to make monthly payments on a partial amount of the cost of the car for a fixed period (typically two or three years). At the end of the agreed term, you then have a choice to make.

You can either:

1. Make a larger final payment, known as the Guaranteed Minimum Future Value (GMFV) or more commonly a balloon payment, to clear the remaining balance to own the car outright.
2. Exchange it for another PCP deal without making the balloon payment. To do this, there needs to be equity either by the current car maintaining a higher value than anticipated by the lender (the GMFV), or you have enough deposit to make this happen.
3. Return the car to the lender and walk away without making any further payments, providing that the vehicle does not exceed the agreed mileage (stated in the finance agreement) or has above average wear and tear.

Advantages of Personal Contract Purchase:

• Lower monthly payments than Hire Purchase or Conditional Sale.
• A low deposit is required at the start of the agreement.
• Unless you opt out, the agreement will be regulated which means you will have rights and protections under law.
• Fixed monthly payments throughout the term of the agreement.
• Flexibility at the end of the agreement on what you would like to do with the car*.

Important things to consider: 

• You must stick to the agreed mileage limit and wear and tear conditions to avoid extra charges at the end of the agreement. Be careful how you estimate your annual mileage as you will be charged for each additional mile at the end of the term.
• PCPs could work out more expensive overall than a Hire Purchase/Conditional Sale agreement due to additional charges (mileage etc); especially if you also decide to enter into a second finance agreement to pay off the deferred future value of the car (balloon payment).
• *Additionally, whilst it may be a benefit for some customers, you do not own the vehicle at the end of the fixed payment term. You are then forced to decide about the ownership of the vehicle, and it may not always be an ideal time to do so.
• As the registered keeper, you are responsible for things such as DVLA Vehicle Tax, insurance, servicing, and maintenance. However, since you do not own the car during the agreement, you cannot sell or modify it without the lender’s permission.

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Lease Purchase

Lease Purchase, also known as "balloon HP" or "low payment plan," is a type of motor financing arrangement similar to Hire Purchase or Conditional Sale. The finance term is typically between two and four years. Under a Lease Purchase you take ownership of the vehicle after completing all payments, but the payment structure resembles that of a lease or rental agreement.

At the start of the agreement, you may be asked to provide advance payments serving as a deposit, followed by regular monthly payments throughout the agreement term.

At the end of the payment structure a balloon payment is due, which is calculated by the estimated future resale value of the car. Factors like anticipated mileage, the car's age and the term of the agreement are taken into consideration when calculating the balloon payment. Lease Purchase is often more affordable for vehicles that retain their value well, such as premium or luxury cars.

Advantages of Lease Purchase include:

• Lower monthly repayments since advance payments are made at the start of the agreement and the balloon payment is deferred until the end.
• This agreement can enable you to often afford a higher-specification car.

Things to consider: 

• At the end of the agreement, returning the car is not an option, and the deferred sum (balloon payment) must be paid; you must have sufficient funds or apply for a second finance agreement to settle the outstanding amount.

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Contract Hire

Contract Hire is a flexible leasing arrangement used to finance vehicle usage and can be made through a motor dealer or finance broker. It is particularly advantageous for VAT registered businesses as they can reclaim the VAT on monthly rental payments. However, Personal Contract Hire (PCH) is becoming more popular with non-VAT registered customers as a means of paying for just the use of a vehicle.

During the term of a Contract Hire agreement, you will pay the total depreciation of the vehicle, along with interest and any additional fees.

At the start of the agreement:

• You agree your annual mileage limit with the dealer/broker which determines the monthly payment. A higher mileage allowance leads to higher monthly payments.
• You agree to pay advance rental payments (like a deposit). These are usually equivalent to three or more monthly payments.
• You sign the hire agreement, and the application is submitted to the leasing company (lessor). If you pass their credit and affordability checks, the lessor pays for the car on your behalf and leases it to you for the agreed term.
• Throughout the agreement, you make the remaining monthly rental payments.

At the end of the Contract Hire agreement you return the vehicle to the lessor.

Advantages of Contract Hire:

• Lower monthly payments compared to Hire Purchase or Conditional Sale for a similar car and term. Payments are based on the expected depreciation of the car, not its initial value.
• Unless you opt out or are a business, the agreement will be regulated which means you will have rights and protections under law.
• Fixed monthly rental payments throughout the agreement term, which can include road tax, servicing, and maintenance plans, offering a convenient way to use a vehicle.
• VAT registered businesses and self-employed individuals can reclaim VAT on monthly rental payments.

Things to consider: 

• Exceeding the mileage allowance results in an additional charge per mile, as stated in the hire agreement.
• Damaging the car beyond "reasonable wear and tear" will require payment of charges outlined in the hire agreement.
• Early termination of the hire agreement is possible but often incurs high termination charges, as specified in the agreement.

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Personal Loans

To fund the car purchase, you obtain a personal loan from a bank or another financial institution. The loan is against you as an individual and not the asset (motor vehicle). Once you have acquired the loan, you visit the dealership and use the borrowed money to pay the dealer.

You immediately become the legal owner upon completing the payment to the dealer but must continue making repayments to your personal loan provider until it is fully paid off.

Personal loans are typically unsecured agreements meaning that the lender has no interest in the vehicle.

Advantages of a Personal Loan:

• Quick and straightforward to arrange.
• You become the owner of the car right away and have the freedom to use or modify it as you choose.
• You can choose the loan repayment term that suits your needs.
• Monthly repayments remain fixed throughout the loan agreement.

Things to consider:

• In a case of financial difficulty, you cannot simply return the car. However, you may choose to sell it to repay any outstanding debt to the lender and do not need their permission to do this.
• Some dealers choose to charge an admin fee if finance is not arranged by them and this may make the overall cost of buying the car more expensive.

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Credit Cards

Once you have found the car you would like to buy, you pay the full amount to the dealer using your credit card. You immediately become the owner of the car and you can use the car as you see fit. You will need to continue to repay the credit card provider until the balance is paid off in full. If you just need to borrow this money for a short period and intend to repay the outstanding amount of credit as quickly as possible, it may be the cheaper option.

Advantages of using a credit card to purchase your car:

• Credit cards are easy to apply for and use and often have a 0% introductory offer.
• You are protected by the Consumer Credit Act for items purchased up to £30,000.
• You often receive rewards from the provider for using your credit card.

Things to consider:

• Credit card loans are unsecured which sometimes means that the interest rates are higher than dealer finance options (check with your card provider).
• There is often a 0% interest introductory period on new credit cards but be aware that as soon as any period of 0% interest finishes you will face a higher rate of interest and these charges will be added to your account.
• You may also be charged a transaction fee for using your credit cards.
• Some dealers choose to charge an admin fee if finance is not arranged by them, and this may make the overall cost of buying the car more expensive.

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Understanding The Overall Cost of Your Finance

Sometimes, car finance deals may look attractive because of lower monthly payments, but there could be a large payment at the end. Some car finance agreements may have higher monthly payments but end up being cheaper overall because you are borrowing the money over a shorter term. It's important to consider interest rates and the total cost of the finance being offered to you, as well as being sure you can afford the monthly repayments until the agreement has been settled in full.

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Read all the paperwork thoroughly.

Before you sign any motor finance agreement, it's important to read all the paperwork carefully. Make sure you understand the terms and conditions, fees, and interest rates. The Financial Conduct Authority (FCA) requires lenders and brokers to give you a written quotation that shows the costs outlining the total amount you will borrow, and this information can be found in the Pre-Contract Disclosure and Adequate Explanation document.

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Check your credit score.

When you want to take out car finance, lenders check your credit score and rating to see if you have the capacity to repay the money. Your credit score is affected by things like paying bills on time and not having too much debt. You can find out your credit score from agencies like Equifax, Experian, or TransUnion. More information about this subject can be found in Vision Funding’s blog titled Credit Scores Explained.

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Consider your options.

You don't have to settle for the first car finance offer you receive. It's important to compare different options so that you get the best deal to suit your individual needs. At Vision Funding, we display to the dealer all the finance options that we receive for each customer and the commission that we earn so that this information can be passed onto the customer. We believe in being transparent so that dealers and their customers can then make an informed choice.

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Ensure that your details are correct.

When you apply for motor finance, it's important to make sure that all the information you provide is true and accurate. Providing false information leads to problems such as notifications being placed on your credit file for other lenders to see, and even possible legal action. Also, make sure that the car dealership you are buying from gives accurate information to the finance company on your behalf.

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Ask questions if you don't understand.

Car finance can be confusing, and that's okay. If you don't understand something, ask questions. Don't feel embarrassed. Ask the dealer, or the finance broker such as Vision Funding, to explain again until you understand everything clearly. If you're still unsure, ask for the information to be provided in writing or a way that you find easier to understand and consider the information at your own pace. Don't rush into a decision if you're not comfortable, and it's okay to walk away.

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Understanding the different car finance options available is important when you want to buy a car. By understanding the different agreement options available to you, considering the overall cost of your purchase, reading the paperwork carefully, checking your credit score, ensuring all your details are correct, and asking questions, you ensure you are making the decisions that are best for you. Remember to take enough time when deciding and don't be afraid to seek help or extra advice when needed.

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