What is Car Finance?

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Car finance options can be confusing, especially if it is the first time that you have considered using it to purchase a car. It's a big decision to make and among the most expensive things we'll buy in our lifetime, before you even consider upkeep and maintenance costs.

Below you will find a guide to the main ways in which people choose to finance a car, which includes personal contract purchase, hire purchase, personal contract hire, and personal loans but there isn't a one size fits all solution to purchasing a car. Different car finance deal options will suit different people based on their needs so it's important to consider each one and figure out which will be best for your circumstances.

Please note that all information provided is a general guide to how these finance products work and that your own circumstances may differ when you come to purchase a car or make an application. John Clark Motor Group is a broker and not a lender so whilst all our sales executives are regulated by the Financial Conduct Authority, we do not give personal finance advice to any of our customers.

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Who Can Apply for Car Finance?

There isn't a set of blanket rules for who can and cannot apply for car finance as most lenders will have their own criteria or cater to a set type of customer.

You will need to be at least 18 years old as the laws around borrowing money are very strict. This can be frustrating if you pass your test at 17 and would like to buy a car with a finance option, as you will need to wait a little bit longer until you are able to do so.

Sometimes a finance company will also place an upper limit on who can apply for finance, for example you must not be older than 79 years old, or they will have specific terms to make sure that the loan is paid off in full e.g. if you are 75 and there is an age limit of 79 you may only be able to take a term up to 3 years.

If you are worried about your credit rating or know that you have a poor credit history, you aren't automatically ruled out from being able to obtain finance. Many dealers will work with multiple lenders who will all have their own requirements for gaining an acceptance.

As well as this, car finance is seen as less risky to finance companies as there is an asset secured against it. This means that if repayments are not made or issues arise, the money that has been borrowed is directly against the car and the finance company can take the car back to recover the costs. This significantly reduces the risk for the lender.

A lender will take into consideration lots of information when considering your application, not only your credit score. This will include things like your affordability, the cost and type of vehicle you are trying to purchase, and any other other monthly costs or outgoings.

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Hire Purchase (HP)

A hire purchase agreement is a great way to finance a new car with fixed monthly payments over a set term and then own your car outright at the end of the agreement term.

Most of the time you will be required to pay a deposit, although sometimes a motor trader will have hire purchase agreements available with no deposit needed, and then the remaining balance to finance will be split into fixed monthly repayments over a set term, usually between 12 months and 60 months. At the end of the agreement you will have what is called an option to purchase fee, which is set by the finance company so can vary, and then you will own the car outright when it is paid.

You will pay interest on the agreement so the longer term that you take, the more interest you will pay which is always something to consider. Interest rates will also vary depending on the lender and your personal application. As previously mentioned, a lender will look at a range of factors when deciding if you are suitable for their finance agreement so you may be offered a different rate of interest.

There are no mileage restrictions applied when you purchase a car with a hire purchase agreement. This makes it ideal if you do a high number of miles. As a flexible finance agreement you also have the option to return the car after you have made payments that cover half the cost of the amount borrowed, which is great is your circumstances change.

White BMW iX in the Scottish hills

Personal Contract Purchase (PCP)

Personal contract purchase, PCP, is a flexible car finance agreement that can offer lower monthly payments in comparison to other financing options. A PCP deal is set up slightly differently to a hire purchase agreement but also gives you more options at the end of the agreement term.

Whilst you still pay a deposit and set a term for your agreement to last, you are also asked to anticipate the mileage that you will be doing annually. The finance company then take this and give a valuation to your car for the end of the agreement, also referred to as the guaranteed minimum future value (GMFV), based on the condition that they expect the car to be in.

The guaranteed minimum future value is fixed and will not change by the time you come to the end of your agreement. This amount is then offset from the balance that you finance and left as a final payment at the end of the agreement, sometimes referred to as a balloon payment, which only needs to be paid if you choose to keep your car. It's worth noting that balloon payments can be thousands of pounds, depending on what value the finance company give you, so you must take that balloon payment into consideration if you would like to own your car.

However, the advantage of this is that you will likely have lower monthly payments than on a hire purchase agreement as the GMFV is not included in the balance to finance.

As mentioned, there are more options at the end of your agreement when you choose personal contract purchase:

  • Hand the car back to the finance company
  • Trade the car in at any dealership for a new car with a new agreement
  • Pay the final payment and own the car outright.

If you choose to hand the car back, this happens at the end of the agreed term and your car will be inspected by the finance company. This is to assess for any damages and to check the final mileage of the car to see if you have exceeded the mileage limit that you anticipated. If there is any considerable damage that they don't deem as acceptable wear and tear for the age of the vehicle you will receive additional charges.

If you have exceeded the maximum annual mileage limits that you had anticipated, for example you had agreed to 10,000 miles per year but have actually done 11,000 per year, then you will pay an excess mileage charge which is usually a set cost per mile. The mileage allowance fee is always stated in your initial agreement so it's wise to check this before you sign the agreement.

However, if you have paid more than half of the original balance to finance you are able to hand the car back at any time which is great if your circumstances have changed or you would like to change your car earlier than anticipated.

As well as this, if there has been a big shift in the market when you come to the end of your agreement and your car is actually worth less than the GMFV it doesn't matter as the finance company have already agreed and fixed this amount when you signed your agreement. They take the loss on the car and you can move onto a brand new car and agreement.

You can choose to trade the car in at the end of your agreement instead of handing it back to the finance company, which is generally what most drivers do as they are changing into another car anyway. You can go to any dealership, not necessarily the one that you purchased the car from, where they will be able to give your car a valuation.

This will be a different valuation from the GMFV as it is based on current market information and the current condition of your car. You will also need to obtain a settlement figure for your finance agreement from the finance company so that the dealer knows how much outstanding finance is on the vehicle. You will then be able to put the two together to find out if you are in positive or negative equity.

Positive equity means that the outstanding finance is less than the valuation of your car. So for example the settlement figure is £5000 and the car has been valued at £6000. The dealership would pay £5000 directly to the finance company to end the credit agreement, and the remaining £1000 would be given to you where you could either use it as a deposit for your next car or have it returned to you.

Negative equity means that the outstanding finance is more than the valuation of your car. For example, the settlement figure is £6000 and the car has been valued at £5000. The dealership would still pay £5000 directly to the finance company but you would need to pay the £1000 difference yourself if you wanted to go ahead with the trade in so that the entire finance balance is settled.

Whilst this is an option at the end of your agreement you can technically trade your car in at any time on a PCP deal although, generally, you will be likely be in negative equity until you have paid at least half of the amount that you have borrowed.

The final option is to keep the car at the end of the agreement which means that you would need to pay the guaranteed minimum future value that the finance company set out at the beginning of the agreement. For example if the GMFV was agreed to be £5000, you would need to pay £5000 to the finance company to own the car.

This is a great option if you really like your car and it continues to suit your needs but may require more planning as the final payment is usually much higher than at the end of a hire purchase agreement.

Black MG ZS sitting in front of the River Tay

Personal Contract Hire (PCH)

Personal contract hire is a different way to finance a car and differs greatly from HP and PCP other finance options as it is a lease agreement with no purchasing option at the end of the term. However as a lease agreement it allows you to continue to change your car every few years without having to worry about resale value.

Similarly to PCP finance, you pay fixed monthly payments over an agreed term and a set number of miles, however it usually offers a lower monthly payment amount which opens your options up to lots of cars that you might not be able to budget for under a HP or PCP deal.

You will need to pay a deposit, also called initial rental, which is usually equivalent to a number of monthly payments, e.g. the initial rental is the lump sum equivalent to three monthly payments. Again, this will vary depending on the lender and the agreement that you choose.

If you go over your mileage allowance there will be a payable excess mileage fee, the same as there is with a PCP agreement, and additional charges will apply if the car has unexpected or unreasonable damage when you return it at the end of the lease.

Some dealers will offer additional packages to add to your lease agreement that will include things like road tax or maintenance to allow you to take care of everything in one payment. You will need to check with the dealer that you are planning to lease from so that you know if these options are available or not.

A PCH deal is great if you're looking for something short term, such as 12 months, or you know that your circumstances will change and you'll want to change the kind of car that you drive. It's also a great option if you don't want the hassle of trading a car in or worry about what the value will be further down the line.

Most of the time you cannot end a PCH agreement early unless you pay the remaining balance of the agreement, which can make things difficult if you are no longer able to afford the car or your circumstances change drastically.

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Personal Loans

A personal loan is another method of funding the purchase of a new car but is not offered through the motor dealer. Instead most people will look to a bank or somewhere similar to borrow the money from and will have no involvement from the dealership you purchase the car from.

This will still involve setting up regular monthly payments but the main difference is that the money borrowed is not secured against the car itself like a car finance agreement is, instead it is what is referred to as an "unsecured loan".

You might find that the interest rate offered by personal loan providers are less than the interest rate being offered on a PCP or HP agreement, which makes it an attractive car finance option. However, if you trade the car in early or if it is written off you will still have to make monthly repayments on the loan until it is paid in full as it is not secured against the car.

You will need to pass a credit rating check in order to obtain a personal loan, and after that you may not get the rate that was advertised if you don't meet the criteria set out by the lender. Some personal loans also have variable interest rates rather than fixed interest rates which means that the payments can go up or down as the rate changes. You'll need to consider this and if you can afford the payment if it increases.

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Frequently Asked Questions

Can Car Finance Be Transferred to Another Car?

No, you are not able to transfer an outstanding finance balance on one car onto another car. Depending on the type of finance you have opted for will depend on how the current car's finance needs to be settled before you can move forward with another car.

Can I Have 2 Cars on Finance Agreements?

Yes you are able to have more than one car on finance if you are deemed to be eligible and are able to keep up with monthly repayments. The lender would need to be satisfied that you will be able to make repayments and will need to allow for you to finance multiple vehicles so it is always best to check with your first lender to see if there are any terms and conditions against multiple finance agreements. Most lenders will not allow you to finance more than one vehicle on the same agreement.

Can Anyone Be Accepted For Car Finance?

Each lender will have their own criteria for who they accept for a car finance application. This is not to say that everyone will definitely be accepted but that different lenders will be suitable for different applications.

Can Car Finance Be Paid Off Early?

Yes, you will be able to settle your finance agreement early in most cases. You will need to contact your finance provider and they will provide you with a settlement figure and instructions on how to pay that balance.

Can I Change a Car That Has Outstanding Finance?

Depending on the type of car finance that you have opted for will depend if you can change a car that has outstanding finance on it. In most cases the car can be traded in and the finance settled but be aware that you may have to pay a balance in order to do so.

What is a Guarantor on Car Finance?

A guarantor is a third party, usually a family member or a friend, who agrees to guarantee the repayment of your finance agreement if you fail to keep up with the payments. It gives the lender more security for the application being made but the guarantor has no claim to the asset being financed.

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