It goes without saying that buying a new car can be quite expensive, especially if you are paying for it upfront. Fortunately, there are a number of financing options available if you don’t have enough money saved up to fund the purchase. Choosing to use credit helps to make your car purchase become more affordable since the cost is spread out in installments over time.
What is car finance?
Car finance is an umbrella term that covers a range of financing options that let you borrow a certain amount of money you need for a new or previously owned car or to lease it for a specified period of time before you can finally purchase it outright.
Approaching a car finance lender is ideal for when you don’t have enough funds to pay the full cost of your preferred car.
How does car finance work?
At the end of the day, all car finance options involve borrowing money from a lender with the intention of using the funds to cover the costs of the car. However, the different finance options all work in different ways. Thus, it is wise to weigh the benefits and downsides of each finance option before settling on one.
You can use any of the following finance options to purchase either a new or used car, however, you will need to first check with the car dealer and the lender.
If you don’t have enough funds to purchase a car outright but have a good credit score, a car loan can prove to be a cheaper option compared to other finance options and will allow you to get a low-rate deal. This is how buying a car through a car loan works:
You first choose the amount that you want to borrow and the term of the loan (how long you wish to borrow it for). If the bank approves your loan application, the funds will be deposited directly to your bank account so you can purchase the car.
After this is done, you will then start paying off the loan in installments.
It is important to note that car loans are unsecured which means that you (not the lender) will have ownership of the car once you buy it.
Purchase contract purchase
When you choose the route of a personal contract purchase plan (PCP), your monthly repayments will be lower than with a car loan. However, if you are looking to retain ownership of the car at the end of the contract, you will incur some additional costs. Here is how a personal contract purchase works:
You first take out a loan. However, instead of covering the full cost of the car, this type of loan covers the depreciation of the car. This is how much the lender predicts the car will drop in value compared to its value when it is brand new.
You will need to put down a small deposit – usually 10% -then pay monthly installments with interest. The term of a PCP typically ranges from one to four years.
Once your contract is over, you will have three options: The first is to return the car to the dealer and move on. The second option is to trade in the car and get into a new PCP plan. And the third option is to make a final payment (known as a balloon payment) to get ownership of the car. The balloon payment is the difference between the outstanding balance and your car’s current worth. The balloon payment can prove to be expensive particularly if the car holds its value.
In case you exceed the agreed-upon mileage or if the car has sustained excessive wear and tear at the end of your contract, you will be required to pay extra.
In the case of a hire purchase arrangement, you make monthly payments to the car finance company. What makes hire purchase different from other finance options is that you will be technically paying to hire your preferred car and you only get to own the car once you’ve completed all the payments. While a hire purchase plan is often cheaper than other options, it has some downsides. Here is how hire purchase works:
With a hire purchase plan, you make monthly payments to hire the car. The monthly payments include the loan plus interest.
It is much easier to get into a hire purchase arrangement than other finance options since hire purchases are offered directly by the car dealer.
Most dealerships will require a minimum 10% deposit, but you stand to benefit better terms the bigger your downpayment is.
The repayment period for a hire purchase is typically up to five years.
A shorter-term hire purchase plan will often be more expensive than a longer-term hire purchase plan.
You get to keep the car the moment you make the final payment.
Leasing your car using finance is another option. This arrangement is also referred to as personal contract hire (PCH). Here, you hire a new car for a specified number of years and return it once your lease period has lapsed. Car leasing is typically considered a long-term car rental.
Same as with a hire purchase plan, you pay a deposit and make payments on a monthly basis. Car leasing also comes with servicing plans at an additional cost. This helps you to make sure that you return the car in good condition and avoid having to pay fines. The main difference between car leasing and hire purchase is that at the end of the deal, you won’t retain ownership of the car and so you can’t resell it to recoup some of your money.
Which is the best car finance option?
The most ideal car finance option for you will depend on your specific situation. However, there are a number of key factors that you need to consider when deciding which finance option will work best for you:
Are you looking to purchase a new or used car?
If you are looking to buy a previously owned car, various finance options may be available. The funds from a car loan can be used to purchase a new or used car while car leasing and PCP arrangements are much more ideal for funding a new car purchase.
Your credit score
If you have a strong credit score, you stand to be approved for more deals. What’s more, a good credit score allows you to get better interest rates too. Thus, it makes more sense to take out a personal loan to fund the purchase of your car than other options. For those with lackluster credit scores, alternative finance options like hire purchase may be a much cheaper option.
Are you comfortable with paying less per month but not owning the car until you complete the payments or do you want to own your car outright but make higher monthly payments?
In the case of a car loan, you will have ownership of the car right from day one after you have paid for the car. On the other hand, with PCP deals and car leasing, you don’t have ownership of the car for the duration of the plan.
Are you planning on selling the car once your deal is over?
If you want to own the car or sell it at the end of your deal, you will want to consider going for a car loan or hire purchase plan.
How do you plan to use the car?
Keep in mind that certain finance options like PCP deals normally have a limit on your mileage.