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Car finance explained – advice guide

March 29, 2021 by

Financing a car is the most popular way in the UK to buy a new car — allowing you to get behind the wheel of something new without having to fork over one large lump sum of cash.

When you buy a new car, you’re almost guaranteed to be offered a finance package no matter if you’re buying from a dealer, broker or car supermarket.

There are four core options when it comes to financing: hire purchase, a personal contract plan, personal leasing, or a personal loan. Some of these options can be a lot to get your head around, so it’s important to understand what you’re signing up for.

The best deal for you will depend on your budget, whether you want to upgrade your car in a few years’ time, and whether you want to own the vehicle outright.

Read on to find the best car finance option for you.

  • Personal contract purchase or plan (PCP) explained
  • What is personal contract hire (PCH)/car leasing
  • Hire purchase: what is it, pros and cons
  • Personal car loan – pros and cons

Personal contract purchase or plan (PCP)

Who offers it? Car dealerships, car supermarkets and finance brokers
What for? Mostly new cars, some used cars, but not private sales
How personal contract purchase works

PCP is effectively a loan – but you don’t borrow the full price of the car.

If you go for a PCP deal, you’ll likely need to place a deposit of at least 10% of the car’s value — sometimes more — and then make monthly payments. These tend to be over the course of three to five years, before having a handful of choices of what to do with the car at the end of the term.

Your monthly payments will be based on the price of the car, the interest rate (APR) and how the car’s value is expected to depreciate.

Depreciation is the key to understanding PCP. Cars will lose value as soon as you drive them off the forecourt, though some lose a lot more than others.

When you apply for a PCP plan, the finance company calculates a predicted minimum value for the car at the end of the agreement. This is called the ‘guaranteed minimum future value’ or GMFV. It’s worth noting that this is factored into the total amount of credit you borrow, too.

At the end of the term you have three options: return the car with no additional fees; pay a ‘balloon payment’ (this will be equivalent to the GMFV) and keep the car or use the resale value towards an agreement on a new car.

Here’s an example:

  • A new car costs £20,000
  • You pay a deposit of £2,000
  • The final payment is £10,000
  • At 5% APR over 36 months the total amount of credit equals £20,108
  • You’d pay £288.80 a month
  • At the end of the term, you’re then left with the option of paying the £10,000 final payment, take an agreement out on another car or just simply handing the keys over

Can you end a PCP agreement early?

PCP agreements can be ended early if you’ve paid 50% of the total amount due to the finance company. The total finance amount will include any interest and fees that you have to pay as well as the balloon payment.

If you haven’t paid half the total finance amount, you’ll need to pay the difference before you can end your contract.

If there’s any damage to the car beyond normal wear and tear, you’ll likely have to pay additional to cover it.

Pros of PCP

  • Some manufacturers may offer a ‘deposit contribution’ towards the cost of a finance package
  • PCPs mean you can change your car reasonably frequently
  • You could be quids in if used car values hold steady or rise during the term
  • If you plan to hand the car back at the end of the term you don’t have to worry about the car’s depreciation
  • Maintenance and servicing packages are often included

Cons of PCP

  • You will need to stick to the terms in the contract, including a maximum yearly mileage. Fees apply if you exceed the stated mileage.
  • You won’t own the car unless you make the balloon payment
  • If your car is worth less than the GMFV at the end of the term, you’ll be out of pocket.
  • If you damage the car, or there is excessive wear and tear, you’ll be charged extra at the end of the term.
  • Balloon payments can sometimes seem unaffordable – especially if your finances have changed since you took out the plans

Personal contract hire (PCH)/car leasing

Who offers it? Car dealerships, car supermarkets and finance brokers
What for? New cars, used cars, but not private sales
How personal contract hire works

PCH, more commonly known as car leasing, is similar to renting a car. You pay a deposit, pay an agreed monthly amount, and get use of the car for the duration of the term. You’ll also have to pay for any damage that occurs during the lease.

Most car leasing agreements run for two to five years, and the deposit is normally equivalent to three to six times the monthly payment. In general, the longer the agreement, the lower the monthly payments.

The key difference between PCH and PCP is that with PCH you will need to hand the car back at the end of the contract – there’s no option to buy it.

Most PCH deals are aimed at businesses. For this reason, many deals are priced excluding VAT. Before you sign up, check if an advertised price includes VAT or not. If not, you’ll need to add 20% to the monthly price to arrive at the amount you’ll actually pay.

Here’s an example:

  • You want a new Range car worth £40,000
  • You put down a £2,008 deposit – this is equivalent to six months of payments
  • You pay £335 a month for 35 months
  • After 36 months you pay for any damage, give the car back and walk away
  • In three years you’d have paid a total of £13,735 for leasing the car


Can you end a PCH agreement early?

PCH deals can be tricky to get out of, though you’ll be able to check your exact terms in the agreement documentation with your finance provider.

Some contracts require you to pay the full amount remaining on your agreement to end it – so this option won’t help if you want to terminate the agreement because you’re short of money.

Other PCH providers may impose a fee of 50% of any outstanding rental period or calculate a fee on an individual basis, taking into account the length of the contract and mileage allowance.

Some leasing companies will allow you to ask to switch your lease to another vehicle, but there’s no guarantee the request will be accepted.

Pros of PCH

  • PCH gives you cost-effective access to new vehicles without the large drop in value that comes with buying a new car outright.
  • Delivery, breakdown, road tax and a warranty are normally included in PCH deals
  • Monthly payments for a similar car tend to be cheaper with PCH than PCP
  • You can change car reasonably often

Cons of PCH

  • Deposit requirements tend to be higher than for PCP
  • You’ll need to pass a credit check for PCH
  • There’s no option to buy the car at the end, no matter how much you like it
  • PCH deals come with mileage limits – there are financial penalties if you exceed them
  • You’ll have to pay for any damage beyond normal wear and tear at the end of the term
  • You might need to pay for the finance company’s permission to take the car abroad

Hire purchase (HP) explained

Who offers it? Car dealerships, car supermarkets and finance brokers
What for? New and used cars, but not private sales
How hire purchase works
HP agreements are pretty straightforward: you pay a deposit (usually at least 10% of the car’s value), and then pay off the value of the car, plus interest, in monthly instalments, over a fixed term. These usually last one to five years.

At the end of the term you’ll pay a ‘transfer fee’ or ‘option fee’ to take ownership of the vehicle. It’s important to understand that you won’t own the vehicle until this payment is made – this means you can’t sell it without the lender’s permission — though this is often relatively inexpensive.

Here’s an example of HP:

  • The car you want to buy costs £14,000
  • You put down a 10% deposit of £1,400 – so you have £12,600 left to pay
  • You’re offered a HP deal at 5% APR over three years
  • This equates to monthly payments of £378 for 36 months
  • After three years you pay a transfer fee of £100 and take ownership of the vehicle
  • In total you’d have paid £15,108 (the £1,400 deposit + £13,608 in monthly payments + £100 transfer fee)

Can you end a HP agreement early?

Under the Consumer Credit Act 1974, borrowers can ‘voluntarily terminate’ a HP agreement once they have paid 50% of the total amount payable. If you’re struggling to keep up with the payments or decided you don’t want the car anymore, this might be an option to take. You won’t get any money back, though.

If you terminate your HP agreement, the car should be in good condition when you hand it back. If it’s not, you’ll have to pay for repairs.

Pros of hire purchase

  • HP is simple and easy to understand
  • You can pick a HP term to suit your budget; the longer the term, the cheaper your payments will be (but the more interest you’ll pay overall).
  • Once you’ve made all the payments and paid the transfer fee, the car is yours to keep
  • If you have a poor credit history, it might be easier to be approved for HP than a personal loan.
  • There are no limits on the mileage you can do each year

Cons of hire purchase

  • The car is owned by the finance company until the last payment and transfer fee are paid
  • Servicing packages aren’t usually included
  • You can’t sell or modify the car during the HP term without permission from the finance company
  • HP can be expensive compared with other car finance options
  • You’ll need a decent credit history to be offered a competitive HP deal
  • If you fail to keep up repayments, the finance company can repossess the car. It won’t need a court order to do this until you’ve paid a third of the total amount

Personal loan

Who offers it? Banks, building societies, peer-to-peer lenders
What for? New cars, used cars, private sales
How personal loans work

When you take out a personal loan, you borrow a fixed sum, then repay it in fixed monthly payments, plus interest. Loan terms vary greatly, but are usually from one to seven years.

Interest rates vary depending on the amount of money you’re boring. Loans for smaller amounts usually attract a higher APR, while loans for £15,000 or more will have a lower APR.

Using a loan to buy a car effectively makes you a cash buyer whether you’re buying a car from a dealer, a car supermarket or via a private sale.

Personal loans can be secured or unsecured. Secured loans are usually cheaper but they will normally be secured on your home – so your property will be at risk if you fail to keep up payment. Unsecured loans are typically less risky but will cost more in the long run.

Here’s an example:

  • You want to buy a car costing £10,000
  • You’re approved for a £10,000 loan from a building society at an APR of 8% over five years
  • Once you have the funds from the building society you pay for the car in cash, cheque or bank transfer
  • You’ll pay the building society £201.43 a month for five years
  • Overall you’ll pay £12,085.83, including interest of £2,085.83

Can you end a personal loan agreement early?

To pay off a personal loan early, you’ll need to ask the lender for a settlement figure. The lender will then tell you the amount you need to pay in full. This will be the amount you owe plus an early settlement charge if applicable. Under the Consumer Credit Act, lenders are able to demand up to two months’ interest as an early settlement charge.

You’ll then have 28 days from when the finance company received your request to pay the amount off in full.

Pros of personal loans

  • There is a wide choice of loan providers from banks and building societies to peer-to-peer lenders and specialist car loan companies
  • You’ll be able to get a competitive interest rate if you have a decent credit rating
  • You can use a personal loan to buy from a private seller
  • As a cash buyer you may be able to negotiate a better price for the car
  • You can pay part in cash for your car, and cover the rest with a loan
  • You own the car from day one and are free to modify it, drive unlimited miles, or sell it

Cons of personal loans

  • You might struggle to find an affordable loan unless you have a good credit score
  • Monthly payments might be higher than for some other forms of car finance
  • As you own the car outright, you’ll be responsible for all repairs and servicing
  • The car’s value will depreciate, so it’ll be worth a lot less than you paid when you come to sell it
  • If you sell the car, you’ll still need to pay off the loan

Car finance FAQs

Can every dealer on carwow provide finance offers?

All dealers on carwow are official UK main dealers. This means they can all provide manufacturer-backed finance offers. They’ll be happy to give you a personalised quote depending on what size deposit you’d like to pay, how long you’d like to keep the car and how many miles you’d like to cover.

Can I take advantage of manufacturer offers when I buy a car through carwow?

You can. Manufacturers may offer further discounts in the form of deposit contributions and low interest rates on some models. Any finance offer you receive from carwow will show applicable finance deposit contributions and APR interest rates. Extra discounts, including manufacturer loyalty schemes, can be added to your existing offer.

Do all manufacturers offer finance packages on their cars?

Yep. All manufacturers provide ways to finance their cars if you’ve decided paying in cash isn’t for you. Specific terms will have to be agreed between you and a dealer, though.

I own my own business – can I take advantage of business rates through carwow?

Yes, you can. When you receive finance offers through carwow, it’s worth notifying the dealers if you’re a business owner or a sole trader – you may be offered different funding options to a private buyer.

Is there anything else I should look out for?

Some dealers may also offer sizable discounts that are, in fact, manufacturer finance incentives – available from any main dealer. If you buy a new car through carwow, you’ll be able to take advantage of both manufacturer deals and individual dealer offers.

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