Car finance explained – advice guide

Most new car purchases in the UK are funded by some kind of finance package. When you buy a new car, the chances are the dealer, broker or car supermarket will offer you a finance deal.

Finance options include: hire purchase, a personal contract plan, personal leasing, or a personal loan. Some of these options can be quite complicated 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 basically a loan – but you don’t borrow the full price of the car.

    With PCP, you’ll need to put down a deposit of at least 10% of the car’s value, and then make monthly payments for three to five years, before having the option to buy the car.

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

    Depreciation is the key to understanding PCP. Cars lose value as soon as you drive them off the forecourt but some models lose their value quicker than others.

    When you apply for a PCP plan, the finance company will calculate a predicted minimum value for your car at the end of the agreement. This is called the ‘guaranteed minimum future value’ or GMFV.
    Your monthly payments are calculated to cover the difference between the price of the car at the start and the GMFV, minus any deposit.

    At the end of the term you have three options: return the car; pay a ‘balloon payment’ (equivalent to the GMFV) and keep the car or use the resale value towards buying a new car

    Here’s an example:

  • A new car costs £20,000
  • You pay a deposit of £2,000
  • The finance company estimates the GMFV will be £10,000 after three years
  • This means you’ll need to borrow and repay £8,000 plus interest (£20,000 – £2,000 deposit – £8,000 GMFV)
  • At 5% APR, over 36 months, you’ll pay £239.37 a month
  • At the end of the term you can choose whether to return the car, pay the balloon payment (£10,000) or trade in the car for a new PCP plan on another car
  • Can you end a PCP agreement early?
    PCP agreements can be ended early if you’ve paid 50% of the total finance amount 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 get out of the contract.

    If there’s any damage to the car, you may have to pay for it.

    Pros of PCP

  • Some manufacturers offer a ‘deposit contribution’ towards the cost if you use their finance package
  • PCPs can suit people who want to change their car frequently
  • You could be quids in if used car values hold steady or rise during the term
  • If you plan to walk away at the end of the term you don’t have to worry about the car’s depreciation
  • Maintenance and servicing 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 until the balloon payment is made.
  • 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 plan.
  • You’ll need to arrange your own fully comprehensive insurance.
  •  

     

    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 or car leasing is basically renting a car. As such, it works like most other rental agreements – you pay a deposit, pay a monthly amount, and get use of the item 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 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 Rover Evoque worth £40,000
  • You put down a £2,008 deposit – this is equivalent to six months’ rental 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 hard to get out of. The finance provider’s cancellation policy will be set out in the contract.

    Some contracts require you to pay all of the remaining instalments to settle the agreement – so this option won’t help if you want to terminate the agreement because you’re short of money.

    Other PCH providers might 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.

    You can ask your leasing company 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 associated with buying a new car outright.
  • Delivery, breakdown, road tax and a warranty are normally included in PCH deals – this makes budgeting easier.
  • Monthly payments for a similar car tend to be cheaper with PCH than PCP.
  • You get the freedom to change vehicles every few years.
  • Cons of PCH

  • Deposit requirements tend to be higher than for PCP
  • PCH is a type of credit agreement so you’ll need to pass a credit check
  • You don’t have the option to buy the car at the end of the agreement
  • 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
  • You’ll need to arrange your own fully comprehensive insurance
  •  

     

    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
    A HP agreement is pretty straightforward: you pay a deposit (normally at least 10% of the car’s value), and then pay off the value of the car in monthly instalments, plus interest, over a term of 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.

    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. You might want to do this if you’re struggling to afford the repayments or don’t need the car anymore.

    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 easy to understand – it’s a simple way to spread the cost of buying a car.
  • 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, you’ll own the car.
  • 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.
  • You’ll need to pay for car insurance, servicing and repairs.
  • 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 are usually from one to seven years.

    Interest rates vary depending on how much you’re borrowing. 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 – putting your property at risk if you fall behind on repayments for your car. Unsecured loans are less risky, but may cost more.

    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 any). Under the Consumer Credit Act, lenders can charge 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 if you buy a car privately
  • As a cash buyer you may be able to negotiate a better price for the car
  • You can pay for some of the car from your savings, and take out a loan for the remainder
  • 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. As a result, 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?

    Yes. On some models, manufacturers may offer further discounts in the form of deposit contributions and low interest rates. 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?

    Yes. 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, however.

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

    Yes. 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 sizeable 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.

    Save money on your next car

    Already know what car you want? Click ‘login’ on our homepage to sign up, configure your ideal model and, when your offers arrive, contact your preferred dealer to discuss your finance options. We also have a range of new, nearly new, pre-reg and ex-demo cars ready to be driven away today.